The recent market pop following the reelection of Donald Trump has left investors with a mix of emotions. While some sectors have benefited from the new administration’s policies, others seem to be struggling to find their footing. The energy sector, in particular, stands out as an area that could ultimately benefit consumers but hurt investors.
The ‘Drill Baby Drill’ Mantra
At its core, Trump’s "drill baby drill" mantra implies lower energy prices through increased domestic production. This is a strategy that could potentially help tame inflation and offset any inflationary policies coming out of the administration. However, this approach also presents a contradictory picture for investors.
On one hand, lower energy prices would be beneficial to consumers, but on the other hand, it could hurt energy stocks in the long run. As Paul Schatz, president of Heritage Capital, pointed out: "Energy stocks have soared post-election on the thesis that less regulation and stronger growth will increase profits and demand. However, ‘drill baby drill,’ which will be good for the sector and energy independence also means more supply on the market, and more supply usually leads to lower prices which are not good for the stocks."
Energy ETFs in a State of Flux
The energy sector has been one of the biggest post-election movers, with bellwethers like the Energy Select Sector SPDR Fund (XLE) and the Vanguard Energy ETF (VDE) up nearly 5% over the past week. However, as financial advisors and market watchers are considering ways to hedge the energy sector in client portfolios, it’s clear that this is a complex issue.
Chuck Failla, principal at Sovereign Financial Group, highlighted the complexities of the situation: "As a standalone, more production generally means lower prices and that’s deflationary. However, there seem to be many, many moving parts pulling and pushing many different levers. So, at this point, I think it’s too early to tell if the net effect of all the changes will be inflationary or disinflationary."
Investing in Energy: A Vague Picture
While lower energy prices would help tamp down inflation and potentially offset any inflationary policies coming out of a Trump administration, the investment strategy presents a vaguer picture. As Joy Yang, head of Index Product Management at MarketVector Indexes, noted: "If you look at some of the investor sentiment around domestic energy, including nuclear and uranium, those policies should be disinflationary. But you have to counter that with some of the other policies related to tariffs. How those will play out is certainly uncertain."
Pricing in Expectations
Yang also believes that energy sector ETFs are already "pricing in expectations," which explains the post-election rally: "We’re seeing people trying to hedge both sides of the outcome." This means that investors are essentially betting on both a higher and lower scenario, which can be a challenging position to maintain.
Separating Economy from Stock Market
Craig Golden, senior investment analyst and market strategist at Nepsis, emphasized the importance of separating the economy from the stock market when it comes to energy: "Even if production increases under a Trump presidency, that doesn’t necessarily mean energy company stocks will outperform across the board. In fact, the revenue and earnings increase from a production boom could be offset by a lower oil price, and the historical data show that energy companies exhibit weaker returns in disinflationary environments."
Conclusion
The energy sector is an area of great uncertainty for investors right now. While Trump’s "drill baby drill" mantra implies lower energy prices through increased domestic production, this approach also presents a contradictory picture for investors. Energy stocks have soared post-election on the thesis that less regulation and stronger growth will increase profits and demand. However, more supply usually leads to lower prices which are not good for the stocks.
As financial advisors and market watchers consider ways to hedge the energy sector in client portfolios, it’s clear that this is a complex issue. The risk of separating the economy from the stock market when it comes to energy cannot be overstated. Investors must carefully weigh the pros and cons before making any investment decisions.
Recommendations for ETF Investors
- Diversify Your Portfolio: With the energy sector in flux, it’s essential to maintain a diversified portfolio to minimize risk.
- Monitor Energy Prices: Keep an eye on energy prices and adjust your strategy accordingly.
- Consider Inflation-Hedging Strategies: Invest in assets that historically perform well during periods of inflation.
- Stay Up-to-Date with Market News: Stay informed about market developments, including any changes to Trump’s policies.
By following these recommendations, ETF investors can better navigate the complexities of the energy sector and make more informed investment decisions.
