My Energy Overweight

If you’ve caught any of my recent appearances on TV, you may have heard me mention a fondness for energy-related equities for the first time in what feels like forever. The energy sector is one of only two overweights in the model portfolios we run, along with healthcare, for 2013.

(Before I continue, nothing you will read in this post is a recommendation for you to do anything – I don’t know you or what’s best for you, so please take these insights as informational only. I know it’s ridiculous that I have to preface a blog post with this but we’ve decided in this society that adults are actually children who cannot be responsible for their own decisions. Okay, disclaimer over.)

We’re playing the energy sector with a long position in Chevron (CVX) established last fall and a somewhat newer holding in the iShares DJ Oil & Gas Exploration and Production ETF, ticker (IEO).

With Chevron, we get a well-positioned global major with $20 billion in cash and a 3% plus dividend yield. Technically, the stock is scratching and clawing at resistance around 117 with a low enough multiple that she should be able to get through eventually.

Through the IEO ETF we get exposure to the white-hot refiners along with the dirt-cheap non-integrated pure play producers like Oxy, Anadarko, Apache, Devon and other names that aren’t usually on the tips of everyone’s tongue these days. A run through of these companies’ charts reveals a great deal of strength beneath the sector rally’s surface. IEO is heavily concentrated – the top ten holdings make up 65% or so of the portfolio, so it’s important for us to be comfortable with them on an individual basis.

The index that IEO is based on is now at highs not seen since early last year before the onset of the Euro breakup / China slowdown freakout.

What’s happening with these stocks is very simple – OPEC is actually cutting production into a an environment in which prices are rising. In the meantime, we’re having something of a renaissance in North America – crude oil output in this country is up by  an astonishing 1.3 million barrels per day and Exxon predicts  the US will be a net exporter of energy within ten years or so at this pace.

Energy was a huge laggard last year, up less than 5% vs the mid-teens return of the S&P 500.  In a post at Index Universe, Paul Baiocchi demonstrates how this underperformance has reversed itself YTD in 2013. It is not peculiar for so drastic a reversal, says Paul, as the energy sector is quite volatile in general.  He notes that:

Over the past 10 years, energy has been either the best- or worst-performing sector seven different times—more than any other sector by a wide margin. It should also come as no surprise when you consider that energy was the second-most-volatile sector (24 percent average annual volatility) behind financials over the past 10 years.

The energy sector’s volatility is primarily a function of the global nature of crude’s supply – demand dynamics and the fact that the fortunes of the sector’s companies rise and fall with the price of energy products themselves.  Last year, when growth expectations for the global economy were muted to dire, oil and gas prices had nowhere to go and energy stocks were out of favor. This year, there is an upside risk that the global economy – fed on a great deal of stimulus from every direction – breaks away from the morass.

Too soon to say if or when this will truly come to pass, but both oil and her related equities are staging quite a dress rehearsal for it.


Energy Sector Humming on Low Volatility (Index Universe)

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