What Happened in the Surprising Equity Sectors of 2016?
Posted on: 12/21/2016
Contributed by Chuck Self, Chief Investment Officer.
a. Energy was the best performing sector in 2016, up 27% compared to a positive 11% for the S&P 500.
b. Through January 2016, energy stocks had fallen almost 50% from mid-2014 levels as West Texas Intermediate crude oil (WTI) prices fell from over $110/barrel to under $30/bbl and natural gas declined from $5.00/million British Thermal Units to $1.60/mmBTUs.
c. In 2016, Energy outperformed for the following reasons:
i. WTI has recovered over 70% since January to $53/bbl.
ii. Natural gas has more than doubled since January to $3.70/mmBTUs.
iii. Both OPEC and non-OPEC producers have agreed to decrease production for the first time in years.
iv. Global growth has increased demand for energy products.
d. We expect these positive trends to stay in place, at least through the first half of 2017:
i. Many energy producers are still recovering from their balance sheet problems of recent years since oil and gas prices are still significantly below the levels where increased investments were made 2 to 3 years ago.
ii. Much of US energy transportation and storage facilities are full not allowing US producers to produce additional energy to take advantage of higher prices.
iii. The supply/demand equation will become in balanced at the beginning of the year as global supply stabilizes and global demand increases.
2. Health Care
a. Health Care was the worst performing sector in 2016, down 4%.
b. Health Care outperformed from 2011 to 2015 due to the implementation of the Affordable Care Act (ACA) providing 20 million new paying patience for the health care system, strong pricing power for drugs and medical supplies, and increased merger activity using the strong cash flow generated from the above.
c. Health Care underperformed other sectors in 2016 due to:
i. Concerns that a new Presidential administration (of either party) would make decreasing drug prices a priority.
ii. Current concerns that the Republican hegemony will cut or eliminate government health programs such as Medicare and the ACA.
iii. Greater scrutiny on pharmaceutical pricing by the public and press.
d. Health Care will continue to underperform in 2016 as:
i. Congressional and regulatory concerns about the sector continue to mount across political lines.
ii. The next Congress may wish to cut or eliminate Medicare and/or ACA to fund their governmental spending priority.
iii. Consumers and medical professional will look for new ways to manage pharmaceutical, medical supply and medical equipment spending impacting revenue growth in the sector.
3. Basic Materials
a. Basic Materials had a strong 2016 with a total return of over 22%.
b. The sector started the year with a major decline as concerns about global recession mounted. As the stock market and the economy recovered, Basic Materials outperformed the broad stock market. After the election, the sector rocketed due to expected strong increases in revenues from governmental infrastructure spending and tariffs of imports and eliminating the minimum wage.
c. Basic Materials has some of the best and worst industries in the market in 2016:
i. Each of the top 8 industries in the Dow Jones US Total Market Index are from the sector. Precious and industrial metals and mining company dominate this list. The prospect for increased industrial demand and concerns about inflationary pressures drove these stocks higher.
ii. Paper and forestry stocks underperformed the broad market. Decreasing prices due to the slowing global economy and low-cost, foreign competition hurt the industry.
d. As 2017 begins, Basic Materials will begin to underperform:
i. The market may have overestimated Congress’ desire to increase the budget deficit and slap tariffs on importers.
ii. Shortage of workers in many materials industry firms could increase labor cost and make the minimum wage non-applicable to more of the sector.
iii. If global economic growth continues to decline, demand for the sector’s products will weaken. Reduced inflationary pressures will impact precious metals prices.