Journal of Investment Strategies

Risk.net

The dynamics of energy futures and equity sectors: evidence from the United States and Canada

K. Smimou

  • Elucidates the tactic of sector-rotation strategy via the inclusion of energy futures.
  • Examines the dynamic relationship between various major equity sectors and energy futures by controlling for the U.S. dollar movement and monetary policy shocks.
  • Documents the predictability role and higher positive impact of energy futures portfolios on some American and Canadian equity sectors.
  • Presents evidence to corroborate the argument in favor of an additional gain to the overall portfolio performance that is more pronounced when using an optimally-weighted energy futures portfolio.

ABSTRACT

This paper investigates a sector-rotation strategy that includes energy futures within a particular economic cycle in order to elucidate two congruent objectives. The first objective is to examine the dynamic relationship between various major equity sectors and energy futures, while endogenously controlling for US dollar movement and monetary policy shocks. The second objective is to assess the benefits of including energy contracts (equally weighted or optimally weighted energy futures portfolios)to enhance the performance and sturdiness of an equity-sector rotation strategy. The findings pinpoint the predictive role and the higher, positive effect of energy futures portfolios on some American and Canadian equity sectors, as well as their negative(or nonexistent) effect on other equity sectors. We find that during periods of high exchange rate, the US dollar has an additional (all direct and interaction) effect on some equity sectors: negative in the case of Canadian basic materials and American energy sectors, and positive in the Canadian financial sector. Further, evidence lends support (through a dynamic assessment of the sector-rotation strategy) to arguments in favor of diversification benefitting overall portfolio performance via the addition of energy futures, a gain that is more pronounced when using an optimally than an equally weighted (or individual futures contracts) energy futures portfolio.

 

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