ETF Trends
ETF Trends

The Energy Select Sector SPDR (NYSEArca: XLE) is up nearly 8% over the past month. Still, bright spots have been few and far between for equity-based energy exchange traded funds this year and that could be emboldening short sellers to target the sector.

With oil prices showing signs of bouncing back, the once downtrodden energy sector could be poised to extend its recent rally. The low oil environment may persist as the Organization of Petroleum Exporting Countries projects demand for its crude to remain lower in 2020 than in 2016 as rivals remain resilient despite the depressed prices.

That could prove dangerous for short sellers running into the sector.

“As oil prices struggle to recover and expected debt default rates climb, the level of energy shorts on the S&P 1500 as a percentage of float, or those available for selling, is at 12.5 percent, approaching the 13.45 percent level financials saw in July 2008 amid the crisis, according to calculations by Bespoke Investment Group,” reports Jeff Cox for CNBC.

Concerns over Chinese oil demand also pressured prices. China revealed that its service activity expanded at a slower-than-expected pace, which has fueled pessimism over a potential slowdown in the second largest oil-consuming country in the world. [China ETFs Suffer New Year Hangover ]

Additionally, the international outrage over Saudi Arabia’s execution of a Shi’ite cleric ended speculation that Organization of Petroleum Exporting Countries could come together on a production cut, reports Simon Falush for Reuters. [Oil ETF Bears Continue Aggressive Forecasts ]

If oil prices falls to new lows and the shale industry is unable to turn a profit, the highly leveraged industry may find it harder to repay debt obligations. With the U.S. dollar strengthening and the Federal Reserve looking at tightening its monetary policy, the various U.S. market sectors and related exchange traded funds could behave differently in a strong USD environment.

“Short interest for energy is at the third-highest level of any sector dating back to 2007 just before the crisis unfolded. Consumer discretionary shares hit 18 percent, also in July 2008,” according to CNBC. “Drillers have been hit especially hard, falling nearly 20 percent in 2016 and about 40 percent over the past year. The top-performing company year to date in the sector has been Spectra Energy, which has gained more than 22 percent. There are only eight stocks in the sector that are positive this year.”

Energy Select Sector SPDR

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.