A market sector that’s found in millions of portfolios is coming under pressure. Here’s why, and where to put your money instead
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Hope to see you there.
***Monday’s Digest highlighted a stealth bull market happening in a sector you may not have believed would be doing well right now
The chart below is of IYF, an ETF that tracks the major U.S. banks. As you can see, the sector just struck a new all-time high. On the year, it’s up 25%.
Now, while growing your wealth has a role for playing “offense” — meaning, putting your money into those sectors like banking that are doing well, investors must also do a good job of playing “defense” — avoiding those sectors that are at risk of underperforming, or even losing your hard-earned wealth.
And right now, while banking is flying high, there’s a different sector facing far stiffer headwinds. That’s what led our own Neil George to recommend his subscribers rotate out of this corner of the market just this past Friday.
The reality is that many investors have money tied up here, so chances are good that your portfolio has exposure to it as well. So, in this Digest, let’s change our mindset from “offense” to “defense,” and with Neil’s help, walk through why this popular market sector is flashing caution lights.
***A tale of two 2019s
As we noted above, the big bank fund IYF is having a monster 2019 so far. It’s up 25% as I write.
But 2019 hasn’t been as kind to another sector …
Below, we compare IYF to XLE, which is the SPDR Energy Select Sector ETF.
As you can see, while IYF is crushing it, XLE is up only 6% on the year.
If we isolate just XLE, notice the clear progression of “lower highs and lower lows” since the spring — a bearish technical indicator.
So, what’s happening here?
Let’s turn to Neil to begin answering that question.
In his most recent issue of Profitable Investing, Neil starts by reminding us that the energy market stretches far beyond U.S. borders. And while the U.S. economy continues to expand, the rest of the world is sputtering. Unfortunately, sputtering economies often mean less demand for energy.
This slowdown is impacting the energy markets. To start, global oil demand slows when there is less global economic growth. The current daily world demand for crude is now running at 99.66 million barrels per day (MBPD), down from the fairly strong and continued demand over the past six years.
So, global demand is down. But as you know, that’s just one half of the equation. What about supply? After all, if macro forces have curtailed supply levels, then the overall supply/demand relationship might remain somewhat balanced, which would keep oil prices stable.
Unfortunately, that hasn’t been the case. Back to Neil:
Despite implemented production cuts by the Organization of Petroleum Exporting Countries and others (OPEC+), as well as impaired supplies due to embattled production from West and Northern Africa, Venezuela and the sanctioned Iran, daily supply is now running at 101.22 MBPD.
But what about the recent attack on the primary Saudi crude processing plant? If you recall, that shut down 5% of the world’s daily oil production. And in the wake of this attack, oil prices soared as some reports suggested it could be weeks or longer before the facility was full back online.
… even with that setback in Saudi production, the overall supplies are still outpacing slowed demand.
This means oil isn’t a growth market right now — at least until a global economic recovery and advancement commences.
***So, let’s translate this into action steps for your portfolio
In his various portfolios, Neil has a collection of stocks and funds in the energy sector. But as market conditions are becoming more challenging, he’s making some changes.
First, Neil suggests investors stay away from the broad, energy-focused ETF, XLE — the same one from our chart above.
… the global slowdown is and shall further negatively impact many to most of the major energy companies. I now recommend selling XLE.
But that’s not the only change. You see, “energy” is a vast sector, which many sub-sectors. And one area in particular that’s facing stiff challenges is the “upstream” exploration and production corner of this market.
Most of the major companies, including ExxonMobil (XOM), have global operations that are on the front line of global woes. These have been leading the sector lower due to their challenging growth prospects. And with low dividend distributions, their yields do not represent a compelling case to own these companies.
So, as a bottom-line takeaway, your average, broad-exposure energy ETF and the major exploration and production companies are both facing challenges. Neil tells us it’s time to rotate out of these positions because our money will be treated better elsewhere.
***On that note, what energy sub-sectors are still worthy of inclusion in your portfolio?
Neil points toward some of the “midstream” players.
The “midstream” pipeline and related toll-takers are where profits continue to flow.
The Alerian Midstream Energy Index tracks the pipeline companies inside the U.S. market. It has seen a total return of 23.59% year to date, vastly outpacing the overall energy sector market.
Pipelines and related assets, including gathering facilities from U.S. shale fields as well as marine terminals for the increasing exports of U.S. crude, continue to find very strong demand.
As Neil explains, pipelines are less at risk of declines in spot prices for crude and natural gas. This is because they’re paid on the volume that runs through the pipes.
Of course, even these mid-stream players aren’t completely immune to a lagging global market. If prices fall too much, margins can be squeezed for even the more efficient fracking producers.
Neil says that the key to being successful is managing counterparty risk. That includes making sure that pipeline capacity is filled through markets that are thick or thin.
***So, what’s one of Neil’s favorite ways to play this?
While he’s still bullish on several different companies, one mid-stream player he likes is Enterprise Products Partners.
Enterprise Products Partners (EPD) is a massive oil and natural gas pipeline passthrough with related assets, including export-focused facilities. It has returned 24.53% year to date. Revenues are up over the trailing year by 24.90%, operating margins are fat at 13.50% and this has delivered a return on shareholder equity of 21.50%.
Ample cash flows and controlled debt give this company the ability to adapt, while its dividend keeps rising in distribution and currently yields 6.01%.
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***Wrapping up, if you’re an energy investor, take a good look at your portfolio today
To what degree are your oil investments exposed to the global slowdown? Do you own exploration and production companies? On the other hand, do you have exposure to the U.S. “pipeline gatekeepers” who are likely to continue doing well?
Here’s Neil for the final word:
… the general overall energy market isn’t working well, so there’s less to compel me to recommend it … the global energy market continues to run into increasing headwinds of slowing economic growth outside the U.S., bringing expectations for subdued demand for oil and gas. This is weighing on traditional E&P companies as well as oil-field service companies … (But) midstream companies continue to provide strong total returns year to date with high dividend income.
Have a good evening,