By Catherine Yoshimoto, Director, Product Management
The Russell 2000 Index closed out 2020 with a roar, surging 31.4% in the fourth quarter and posting its highest ever monthly return in November. A closer look at performance on a sector level reveals Oil, Gas and Coal as the third highest performing Russell 2000 sector for the quarter, bolstered by resurgent hopes for a quicker US recovery from the pandemic crisis.
However, while Oil, Gas and Coal delivered 50.1% for the quarter, it was far from one of the highest contributors to the Russell 2000 Index return—a result of its relatively small weight in the index. And if we look back over the past decade, we can observe that Oil, Gas and Coal has been on a steady decline, leaving us to wonder whether the Q4 rally is sustainable or merely a dead cat bounce.
Accelerated recovery hopes fuel rebound
The March 2020 onset of the pandemic roiled all sectors but dealt a particularly sharp blow to the Oil, Gas and Coal sector, as global energy consumption plummeted amid widespread lockdowns. The Russell 2000 Oil, Gas and Coal sector was down 45.1% for the month of March alone—and continued to lag other sectors as they rebounded in subsequent months.
This trend reversed in late 2020, as news of promising developments for several COVID-19 vaccines lifted hopes of an accelerated recovery that could bring energy consumption to pre-pandemic levels. As shown below, Oil, Gas and Coal was one of the highest performing Russell 2000 sectors in Q4 2020.
Fossil fuel stocks running on fumes?
While the Oil, Gas and Coal sector staged a noteworthy comeback in Q4, longer-term data points to a sector on the decline. The sector’s weight in the Russell 2000 has steadily diminished over the past 10 years, from 3.7% as of 12/31/2010 to just 1.8% of the Russell 2000 Index as of year-end 2020—cutting its weight by more than half in a decade.
This trend illustrates that the Oil, Gas and Coal sector no longer has the clout it once did in the Russell 2000. Despite being a top Q4 sector performer, it was the 13th top sector contributor to index performance for the quarter—contributing far less to the Russell 2000 return than it would have a decade ago.
Is an Oil, Gas & Coal rally sustainable amid the rise of sustainable investing?
There are significant headwinds underpinning the Oil, Gas and Coal sector’s decline, most notably market participants’ paradigm shift toward more sustainable investing. According to Morningstar, interest in US sustainable index funds is exploding, attracting $36.1 billion in net inflows over the past decade, of which 82% was invested in the 18 months to June 2020. And since the dawn of ESG investing, screening out fossil fuel companies has been a key feature of sustainable funds—making the future of oil, gas and coal companies more uncertain as adoption of sustainable investing rises.
Alternative Energy sector performance further underscores this trend. While the Oil, Gas and Coal was the third top performing sector for Q4, Alternative Energy held the top spot both for the quarter and for the entirety of 2020. Thus, while investors expressed optimism for an Energy rebound, expectations for increased Alternative Energy consumption outpaced those for traditional fossil fuels.
These are all important considerations when assessing whether the Oil, Gas and Coal rally has the legs to bring the sector back to life, or whether it can be categorized as a dead—or perhaps dying—cat bounce. While Q4 has undoubtedly been a comeback story for the battered sector, the catalysts behind its decline over the past decade remain—and could have the potential to grow even stronger.
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 Based on predecessor RGS index, Russell 2000 Non-Renewable Energy Index.
 Morningstar, Passive Sustainable Funds: The Global Landscape 2020
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