Over the past year, the Energy Select Sector ETF (XLE) has been out of favor with investors, made 52-week lows, and had several false buy signals. In August, the sector finally turned around and is making 52-week highs since touching a low of $61.80USD. The key drivers for the XLE’s strong performance include a depreciating dollar, rising oil prices, and global growth.
The demise of the US dollar continues
The dollar has been falling due to inflationary concerns, a possible trade war, and strength in the basket of currencies tied to the dollar. The Federal reserve has been increasing rates in order to curb inflation, but it seems like they are falling behind. The US dollar index, which is calculated using six major world currencies, has lost 3.15 percent YTD and nearly 11 percent over the past 12 months. These are huge moves in the FX world — especially for the USD.
The euro makes up more than 57 percent of the index weighting; therefore, its appreciation has been putting significant pressure on the USD index due to a hawkish stance from the European Central Bank. All signs point to further weakness in the dollar as it continues to make lower lows.
China & Emerging Markets continue to push global growth
China’s manufacturing has picked up, subsequently causing growth in demand for the oil needed to facilitate economic expansion. China’s manufacturing PMI and the Caixin/Markit manufacturing Purchasing Managers’ Index both indicate economic strength for the world’s third largest economy (trailing only the US and EU). We see China’s strength reflected in the iShares China Large-Cap ETF (FXI). Emerging markets are also performing strongly, which is reflected in iShares MSCI Emerging Markets ETF (EEM). Both the FXI and the EEM are making 52-week highs.
Rising oil prices
Commodity prices, which are priced in USD, are some of the biggest beneficiaries of a weak dollar. Oil prices have soared, in turn sending the XLE to 52-week highs. The XLE is the easiest way to gain exposure to a basket of stocks tied to Oil. Exxon (XOM) and Chevron (CVX), which makeup ~39 percent of the XLE are at, or near, 52-week highs. Ever since breaking out above $50 a barrel, oil prices have not looked back, and they continue to move higher. When looking at the five year chart below, we are seeing levels not seen since 2014. The trend in oil is strong as we are making higher highs on a near daily basis, and with the falling dollar, it’s not likely to change course anytime soon.
XLE is trading at $77.71. It recently made 52-week highs and is trying to get through the high of $78.45USD we hit in December 2016. The ETF is gaining strength relative to the S&P 500 and has huge potential to move higher given its underperformance since June 2015. If we are able to break through upside resistance, we will likely make a run towards $85-$90USD. On the other side of the trade, we see very little downside risk as we should see solid support near $76USD.
So, what’s next?
Recent trends will continue. The US dollar will continue to weaken, global expansion — led by China and Emerging Markets — will continue, and oil prices will rise. The XLE should resume making higher highs as energy stocks reap the benefits of higher oil prices. Another sector to keep an eye on is the solar sector. Alternative energy is a way to avoid higher oil prices and it stands to reason that investors may look to hedge their exposure by pouring money into this space. An investor can gain exposure to solar stocks through the Guggenheim Solar ETF (TAN). On the flip side, investors should be trimming back exposure to both Utilities and Real Estate related equities over the near-term. Both sectors are likely to see significant outflows given their negative correlation to rising rates.
* Data is of 1/24 market close.
Rodney Raanan, CMT is the Director of Capital Markets & Market Intelligence at Q4 Inc. Rodney works directly with C-level executives of publicly traded companies by providing real time money flows, stock activity updates, options analysis, and technical analysis. Rodney has over 10 years of capital markets experience as an equity trader and an analyst. Follow Rodney on Twitter and Linkedin.
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