Sector Strategy Takes Fleet Feet, Sharp Eyes
Dirty and dangerous," the job description for the "roughnecks" who drill oil, also describes the task ahead for investors in the oil industry.Skip to next paragraph
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Oil prices have plunged roughly 30 percent since October, dragging down oil sector companies from a profit gusher earlier in 1997.
The price downturn underscores what analysts consider a promising but risky opportunity - exploiting the whipsaw price volatility of oil.
The strategy: Invest in oil users - such as airlines - when prices are low, then shift to oil producers as prices rise.
The plan is an example of sector investing, based on the idea that at any given time, some industries will beat the broad market averages.
In fact, a hallmark of the current bull market has been "sector rotation," as investors flock to hot industries, then flee to others that start to look more promising.
Last year, the spotlight shifted from semiconductors to oil to software. In the first quarter of 1998, telecommunications was the place to be.
In many broad-based stock funds, managers follow sector trends. But investors can make their own calls, and focus their money more aggressively, by buying funds that focus on a single sector.
Sector-fund investing requires homework and a tolerance for risk.
To execute the airlines-to-oils strategy, for example, investors need a sense for pricing in the oil market.
Still, with oil prices near historic lows, the oil companies are comparatively cheap, analysts say.
"Oil stocks are quite arguably the best value in the market today," says Tom Petrie, chairman of Petrie Parkman, a Denver energy consultancy. "We are setting up for probably the best cycle in energy investing in 20 years."
The strategy depends on a hazy but plausible pricing forecast:
Phase 1. A period of weak oil prices, favoring airlines. Analysts doubt that a March 30 pledge by the Organization of Petroleum Exporting Countries (OPEC) to cut production by 1.25 million barrels a day will do much to buoy prices.
"The recent uptick is not sustainable," says Nizam Sharief, an analyst at Hornsby & Co. in Houston.
OPEC meets just 41 percent of world oil demand and lacks the leverage to cap production. Non-OPEC producers like Russia will cash in on any price rise by stepping up production, say analysts.
Moreover, East Asia shows no signs of reviving the robust oil demand that collapsed last fall with the region's financial chaos.
Consequently, oil prices will probably drift between $14 and $17 per barrel until the world burns off its surplus, analysts say.
This stands to benefit airlines, where fuel represents 13 percent of costs.
Profits for US carriers should increase 15 to 20 percent over last year, compared with about 5 percent for the broad market, says Glenn Engel, airlines analyst at Goldman Sachs & Co. in New York.
And airlines have moderated their long-standing boom-bust cycle by slowing the growth in capacity. They have also squeezed costs, most notably for food and travel-agent commissions.
These stocks are comparatively cheap, relative to their earnings, "even though their earnings are growing much faster than the overall market," Mr. Engel says.
One way to buy into this opportunity is the Fidelity Select Air Transportation Fund (800-544-8888), up 17.2 percent this year.
Phase 2. A long-term run-up in oil prices to at least $28 a barrel, favoring stocks of oil producers.
The runup will gain force some time in the next five years, after oil producers tap more than half of the oil in developed reserves. Spiraling demand from India, China, and other developing countries will also pump up prices, analysts say.
This forecast has its skeptics, who note that experts frequently overestimate oil price gains and underestimate how technology can uncover and develop new supplies.
Some top-ranked energy sector funds include Invesco Strategic Energy (800-525-8085), Vanguard Specialized Energy (800-662-7447), and Fidelity Select Energy Service (800-544-8888), which focuses on companies that supply equipment and services to oil producers.
Why to invest in sector funds
Financial advisers suggest putting at least some of your portfolio into sector mutual funds because:
* Of the way the market works. It steadily churns money in and out of the most and least promising industries. Investors who identify a promising sector can beat the broad market.
* Of the need to reduce risk. Sector-fund investing gives diversification in more than one company, while netting the profits that can come from investing in a booming slice of the economy.
* With stock prices in the aging bull market quite high, stocks are less likely than in recent years to move in lockstep. So careful sector picking can bring above average yields.