While the stock market (NYSE: SPY) has been spectacularly strong over the past decade and year, energy stocks (NYSE: XLE) have been one of the underperformers. This is not entirely surprising. Energy stocks outperformed in the previous bull market as oil climbed from under $20 per barrel in 2001 to over $150 in 2008 due to rising Chinese demand, decades of underinvestment in oil production, and hysteria about "peak oil".
The high oil prices led to massive investments in energy exploration which resulted in increased production at cheaper prices. While most assets and commodities have made new, all-time highs during this bull market, oil has not. This has also contributed to the length of this bull market as inflation pressures have been muted, allowing central banks to keep monetary policy loose for much longer than previous cycles.
Oil's underperformance has only intensified in recent months. Since October 2018, the global economy has been slowing due to the business cycle turning lower, domestic Chinese weakness, and effects from the trade war. In turn, central banks have been lowering rates on a global basis. The slowing growth is lethal for assets connected to the real economy like oil, but it's been great for assets connected to the financial economy like stocks and bonds.
There had been some hope entering the year that this dynamic could change especially if the manufacturing sector would continue to rebound given that inventories need to be replenished and "phase 1" of the trade deal had been passed. This outcome would lead to interest rates moving higher, cyclical stocks outperforming, and some mean-reversion in these extended trends.
However, the coronavirus outbreak has basically blown up this possibility at least for the next three to six months. Large parts of China and the global manufacturing supply chain have been shut down. This will have spillover effects on consumption and production all over the world. Central banks will loosen policy further and/or maintain already low rates.
Short-Term vs Long-Term
Therefore in the short-term, investors should not look to bet on energy stocks. However, long-term investors should start studying the best companies in the sector. At some point, this trend will mean-revert and deliver fantastic returns to investors just like the opposite trend reversing did in 2008 to energy bears.
For example, Exxon Mobil (NYSE: XOM) is trading at the same level it was in 2011. Over this same period, the S&P 500 is 160% higher. In 2011, Exxon Mobil paid out $5.58 in dividends for a yield of just over 2%. Currently, the company is paying nearly $13.50 in dividends for a yield of 5.8% over the past 12 months.