Energy ETFs Look to Establish Leadership

January 2nd at 11:00am by Tom Lydon

Last year was an excellent one for U.S. equities with the SPDR S&P 500 (NYSEArca: SPY) posting a gain of 32.3% when accounting for dividends paid.

However, big energy was something of a big laggard last year. Twenty-one of the 30 members of the Dow Jones Industrial Average posted 2013 gains of at least 20%, but Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), the two largest U.S. oil companies, were not on that list. Underwhelming performances by those oil giants weighed on some popular energy ETFs.

For example, the Energy Select Sector SPDR (NYSEArca: XLE) was merely the sixth-best of the nine sector SPDRs last year, beating only its materials, staples and utilities counterparts. Exxon and Chevron combine for nearly 31% of XLE’s weight. The good news is energy stocks are cheap.

“Energy stocks also have the lowest price/earnings, price/sales, and price/cash flow ratios of any equity sector. Along with its attractive relative valuation, the sector is also in solid financial condition. In fact, the energy sector’s debt as a percentage of total capital is the lowest of any sector,” according to Morningstar analyst John Gabriel.

Still, XLE and rivals such as the Vanguard Energy ETF (NYSEArca: VDE) lagged the S&P 500 last year even as U.S. oil production soared. The U.S. shale boom has the world’s largest economy rivaling the likes of Russia and Saudi Arabia for global oil production dominance and it will be just a matter of time before the U.S. is passed by China for title of world’s largest oil importer. [Oil ETF Looks to Breakout]

Integrated oil stocks, almost a third of XLE’s weight, were left behind last year and although oil services companies appear to be finding a groove of sorts, that sub-industry represents just 17% of XLE’s weight. [Oil Services ETFs in a Cyclical Groove]

Additionally, the energy sector is becoming increasingly correlated with the broader market. “Over the years, the diversification potential of XLE seems to have been eroding. Over the trailing 10-year period, it has been 70% correlated with the S&P 500. However, over the trailing five- and three-year periods, XLE’s correlation to the S&P 500 has increased to 84% and 88%, respectively,” according to Morningstar.

Medium-term upside catalysts for XLE and its marquee constituents include the aforementioned compelling valuations, sturdy balance sheets, dividend increases (Exxon and Chevron both have multi-decade payout increase streaks going) and the potential for the return of medium- to large-scale energy sector mergers and acquisitions activity.

Five of XLE’s top-10 holdings closed five percent or more below their respective 52-week highs on Tuesday.

Energy Select Sector SPDR

 

ETF Trends editorial team contributed to this post.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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