Energy funds have dropped to 10-year and all-time lows in reaction to a barrage of short- and long-term headwinds. While the coronavirus outbreak and downturn in crude oil prices have generated a good portion of this selling pressure, major political and socioeconomic forces are at work as well, with climate activists putting pressure on large international banks and hedge funds to divest from fossil fuel exposure.

The industry is to blame for the majority of the current downturn, with over-production, high debt levels, and poor management at all levels of the energy food chain. These negative forces can co-exist with higher prices when crude oil demand is strong, like it has been through the decade-long economic expansion, but a downturn or major recession is likely to undermine profitability and send the weakest components into bankruptcy, like it did in 2015 and 2016.

On the flip side, political pressure could backfire because a reduction in worldwide crude oil and natural gas production would shift the supply-demand equation, making those stocks far more attractive. In turn, that would make it easier for big players to expand operations and force opportunistic funds back into sector exposure. The tobacco industry provides an excellent example of this reactionary force, with many components posting excellent 20-year returns.

It isn't too late for energy investors to take defensive steps to protect their portfolios. Most importantly, small explorers and producers will be most vulnerable to bankruptcy if selling pressure continues in the coming months. It makes sense to reduce exposure in these instruments while there's still time, even if it means taking large losses. Of course, blue-chip multi-nationals are vulnerable as well, but high liquidity and even higher dividend yields should ease the pain.

XLE Long-Term Chart (1998 – 2020)

Long-term chart showing the share price performance of the SPDR Select Sector Energy ETF (XLE)
TradingView.com

The SPDR Select Sector Energy ETF (XLE) came online in December 1998 in the mid-$20s and promptly sold off, posting a low at $21.66 in March 1999. The subsequent advance topped out in the mid-$30s in the third quarter of 2000, while multiple breakout attempts into May 2001 failed, yielding a downtrend that ended at an all-time low in the upper teens in the summer of 2002. Committed bulls took control into 2008, carving a historic uptrend into the 2008 high at $91.42.

The fund fell to a four-year low during the economic collapse, bottoming out in the upper $30s in March 2009, ahead of a recovery wave that completed a round trip into the prior high in 2014. An immediate breakout failed after posting an all-time high at $101.52, marking the end of the five-year uptrend. Crude oil plummeted to multi-year lows in the following 18 months, dropping the fund to a six-year low in the first quarter of 2016.

Donald Trump's election in 2016 signaled a boom in U.S. energy production, but the fund failed to capitalize on the apparently bullish backdrop, topping out at the 50% sell-off retracement level in December. Bulls failed two breakout attempts in 2018, carving a triple top pattern that broke to the downside in December. Four lower highs in 2019 added to technical damage, ahead of a breakdown through 2016 support this week.

XLE Short-Term Outlook

The downtrend has also broken support at the .786 Fibonacci retracement of the 2009 to 2014 uptrend, significantly raising the odds that the sell-off will print a 100% retracement into the 2009 bear low in the upper $30s. That level marks exceptionally strong support, but an uptrend starting at that trading floor will face multiple layers of resistance put into place in the past six years, limiting upside potential.

The Bottom Line

Energy funds have dropped to the lowest lows since the 2008 economic collapse in reaction to multiple short- and long-term headwinds.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.