Oil and energy sector stocks performed poorly for most of 2019 because of sluggish growth in China and a weaker economic outlook from the European Union. That trend has persisted into 2020 thanks to the recent coronavirus outbreak and heightened fears of a further drop in demand for energy. Nevertheless, there’s hope for investors looking to profit from the energy sector in the near future.
That’s because energy stocks tend to perform well at this time of the year. Specifically, the sector has a strong seasonal period from Feb. 25 to May 9. From 1984 to 2019, the energy sector in the U.S., as represented by the NYSE ARCA Oil and Gas Index has produced an average gain of 6.9 per cent and has been positive 81 per cent of the time during this period. In addition, the energy sector has outperformed the S&P 500 index 75 per cent of the time during this seasonal period. (As the same variables that affect the U.S.’s energy sector influence its counterpart in Canada, the seasonal period is similar here as well.)
The seasonal period for the energy sector is largely the result of supply and demand imbalances that occur in late winter and early spring. The largest demand for oil during the year takes place as the driving season starts in spring. The official start of driving season occurs on Memorial Day, which lands on the last Monday in May.
In late winter, refineries switch to producing summer gas from winter gas while a large number of refineries go through a maintenance cycle to prepare for the increased demand for gasoline because of the coming driving season. On average, that leads to an increased demand for oil as the driving season approaches.
From a seasonal perspective, it’s best to enter the energy sector in late February and exit in early May, just before the driving season gets underway. The goal is to enter the sector before other investors increase their allocation to energy stocks in anticipation of increased demand for oil and exit as investor interest in the sector peaks just before the start of the driving season.
In other words, the objective of the energy seasonal trade is to take advantage of other investors’ behaviour, getting into the sector before other investors are interested and exiting when there’s maximum interest in the sector.
There are many variables – including geopolitical risk, policies from the Organization of the Petroleum Exporting Countries and its allies (known as OPEC+) and others – that affect the price of oil and energy stocks. If the coronavirus that’s currently a global emergency has a much larger impact than expected, then the energy sector could deteriorate further as global economic growth slows down – or vice-versa.
Still, the aim of investing on a seasonal basis is not to predict the impact that various variables can have on these investments, but to increase the probability of success based upon seasonal patterns caused by a recurring annual pattern. Although the recent correction in energy stocks has created some negative headlines, its poor performance just before the start of the sector’s seasonal period could end up being a good set up for a positive seasonal trade.
Brooke Thackray is research analyst at Horizons ETFs (Canada) Inc. He focuses on technical analysis and seasonal investing.