What Oil Price Swings Can Teach Us About Investment Sectors
Investors have seen almost historic price swings in the markets. As of January 13, 2016, the Standard and Poor’s (S&P) 500 index is down over 7.5% for the year.
One big impact on the market is the decline in the price of oil. Oil prices have declined by more than 60 percent since June of 2014. As of mid-January of ’16, the $30 per barrel price of oil is the lowest price since 2004.
The change in oil prices- and the impact of stocks- is a great way to explain the concept of investment sectors.
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A slight turn of a light bulb in the socket
So, I’ve got a slight short in a light bulb socket in the bathroom. If I turn the light bulb slightly, the light stays on. This is a great way to explain sector funds. By adding more of one sector- and reducing your investment in another- you can slightly change the performance of your portfolio.
Defining investment sectors
An investment sector is broadly defined as a group of stocks in the same industry. Bloomberg provides a list of the typical investment sectors. Utilities, health care companies and financial firms are all examples of sectors.
Take a look at the year-to-date price performance for these sectors. While the broad markets are down around 7.5% so far this year, the performance of individual sectors can be very different. As an example, the utility stock sector is up .84%, while the material sector has declined nearly 10% (as of 1-14-16).
The fluctuation of a given sector can be very different from the broad markets.
Sector investing
Investors have the ability to invest in mutual funds, ETFs and other investments that are focused on specific industries. Say, for example, that you wanted to invest in the utility sector. The Fidelity site gives you options for a sector mutual fund and a sector ETF.
Risks, beta and sectors
A calamity in the economy can have a very different impact on a given sector. Take oil prices as an example. If you’re a transportation company (trucking), you certainly benefit from a decline in oil prices. Lower oil prices also lower the cost of production for consumer goods (think Tide laundry soap) and the food industry.
On the other hand, every business that has a hand in finding oil and refining it into gas will suffer. Their top line- their revenue- has fallen dramatically over the last 18 months.
Beta measures the volatility of a particular stock price in comparison with the broad market. If a stock’s financial performance is closely tried to the price of oil, large swings in oil prices mean more stock price volatility.
The way to track that volatility is to check the stock’s beta. You can monitor the beta of a particular stock, or an entire sector.
Changing your portfolio- and the related risks
If you were concerned about falling oil prices (and the stocks that are affected), you might shift your portfolio away from stocks that are negatively impacted by falling oil prices.
But keep this in mind: If you change the portfolio, you’ll change the risk profile of the portfolio. The beta of your new portfolio may be different than your original one.
Food for thought- as always, this information is for educational purposes only.
Have used any of these ideas? I’d love to hear from you.
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(email) ken@stltest.net
(website and blog) https://www.accountingaccidentally.com/
(you tube channel) kenboydstl
Image: (CC) Sue Waters CC by SA-2.0