What Happened in the “Surprising Equity Sectors” of 2015

By iSectors Chief Investment Officer, Chuck Self on December 15, 2015

Energy  

  1. Energy was the worst performing sector in 2015, down 25% compared to a negative 2% for the S&P 500.Surprising Equity Sectors 2015                           Source:  Barchart.Com
  2. At the end of last year, energy analysts were calling for a rebound in oil prices from the then current price of $53/barrel (West Texas Intermediate) to $80/bbl WTI equivalent (Reuters). 
  3. Energy underperformed other sectors in 2014 due to:  Declining, instead of rising, oil prices. WTI has recently fallen to $35/bbl.  In the meantime, production continues strong outpacing current demand.  These low prices have moved from being an income statement problem (earnings decline, dividend cuts) to a balance sheet problem (need for debt restructuring or bankruptcy).
  4. Although these negative trends are in place as 2016 begins, oil prices could turn around in the second half of the year:
    – As oil producers’ price hedges mature, the ability to pump oil profitability will decline.
    – These same producers are seeing reduced access to the capital markets to cover operating and long-term funding needs.
    – Both of these trends will lead to a significant decrease in crude oil supply in the second half of the year and bring the supply/demand equation in balance.

Consumer Services

  1. Consumer Services was the best performing sector in 2015, up 4%.d. Although these negative trends are in place as 2016 begins, oil prices could turn around in the second half of the year: i. As oil producers’ price hedges mature, the ability to pump oil profitability will decline ii. These same producers are seeing reduced access to the capital markets to cover operating and long-term funding needs iii. Both of these trends will lead to a significant decrease in crude oil supply in the second half of the year and bring the supply/demand equation in balance                      Source:  Barchart.Com
  2. Until this year, the slow recovery has kept consumer spending (especially for non-essentials) at a modest pace.
  3. In 2015, Consumer Services outperformed for the following reasons:
    a.  Consumers have been rebuilding their balance sheets throughout the recovery.
    b.  Sustainably low energy prices reduced gasoline and utility expenses and allowed consumers to spend more on non-essentials such as home improvements and restaurant meals.
    c.  The stronger employment picture and continued low interest rates contributed to consumer confidence.
  4. It will be a mixed bag for the consumer services sector in 2016:
    a.  Economic growth will continue and interest rates should remain low allowing consumers to fit these services into their budget.
    b.  Any signs of employment concerns from a too-aggressive Federal Reserve or a rebound in energy prices will lead to declines in this sector’s revenues.

Utilities

  1. Utilities was one of the worst performing sectors in 2015, down 12%, after outperforming the S&P 500 in 2014.Surprising Equity Sectors 2015                    Source:  Barchart.Com
  2. Given that 30 year Treasury rates moved only slightly up from 2.75% to 2.88% and the input prices for many of these companies’ production processes (oil, natural gas, coal) dropped precipitously, investors could have been happy to own these stocks.
  3. Utilities underperformed in 2015 due to:
    a.  Concerns about the Federal Reserve’s pace of increasing interest rates impacting these companies’ financing costs.
    b.  Competition from accelerated increases in yields in other income sectors such as real estate investment trusts, master limited partnerships, and high yield bonds.
    c.  Investors’ focus on cyclically strong sectors such as Consumer Services and Technology.
  4. These trends should continue in 2016 resulting in another year of underperformance for the Utilities sector.

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