With many market observers assuming it is a foregone conclusion that the Federal Reserve will raise interest rates this year, either in June or in September, investors are turning their attention to the exchange traded funds that have the potential be durable in rising rate environments.
That includes scores of sector funds, including the usual suspects regional banks and insurance ETFs. Historical data indicate if rates rise, investors would do well to also consider beaten-up energy sector ETFs. [Rising Yields Lift Insurance ETFs]
After ranking as the worst of the nine sector SPDRs last year with a decline of 8.7%, the Energy Select Sector SPDR (NYSEArca: XLE) is down another 2.7% this year as oil prices have continued faltering. However, energy sector headwinds do not alter XLE’s potential to be a positive idea when rates rise.
“Not a single sector outperformed in all three of the previous tightening cycles of 1994, 1999, and 2004, although such areas as capital goods and technology performed well in two out of the three,” reports Julie Verhage for Bloomberg, citing Credit Suisse.
In two of those three tightening instances, the energy sector outperformed after Fed “lift off.” During equity market pullbacks related to rising rate fears, the energy sector also outperformed in two of three instances, according to Credit Suisse.
During the 2004 through 2006 rate tightening cycle, XLE was the standout among the nine sector SPDRs, surging 122% and delivering gains that were than triple those of the Financial Select Sector SPDR (NYSEArca: XLF) and nearly quadruple those of the S&P 500. [Winning Sector ETFs for Rising Rates]
Energy has also been the top-performing sector over the Fed’s last seven tightening cycles.
The energy sector has been an attractive play from a so-called mean-reservation perspective – the idea that prices and returns eventually move back towards the mean or average. Now that the energy sector has experienced a large pullback, traders are anticipating the sector will at the very least revert back to its historical average.
Oil companies have announced cuts to spending budgets and some have diminished share buybacks in response to a 60% plunge in oil prices since the June high. Oil’s woes have not prevented investors from embracing XLE. The ETF has pulled in $900.2 million in new assets this year.
Energy Select Sector SPDR