The Energy Select Sector SPDR (NYSEArca: XLE), the largest equity-based energy exchange traded fund, is higher by nearly 29% year-to-date, good for one of the best showings among all non-leveraged sector ETFs.
The Guggenheim S&P 500 Equal Weight Energy ETF (NYSEArca: RYE) has been the best performing broad energy sector-related ETF of the 2016, jumping more than 37%. While some advise caution on the energy sector heading into 2017, other investors believe the group can keep delivering.
A primary reason for the recent bullishness regarding crude is the production cut announced earlier this month by the Organization of Petroleum Exporting Countries (OPEC). OPEC plans to diminish output to a range of 32.5 to 33.0 million barrels per day from its current estimated output of 33.24 million barrels per day. While Saudi Arabia, OPEC’s biggest producer, has agreed to reduce output, Iran, Libya and Nigeria might not follow suit.
In addition to tumbling oil prices, one of the primary reasons investors ditched equity-based energy ETFs like XLE last year was the erosion of the energy sector’s allure as a dividend destination. In 2014 and 2015, no sector saw as many negative dividend actions, including cuts and suspensions, as did energy.
“The other factor is that the economy is improving. This will help drive demand higher for oil and natural gas consumption and for oil based plastics and other products. The improving economy is reflected in forecasted U.S. GDP growth of 2.1% in 2017. This is higher than the 1.9% growth that the U.S. economy achieved in the first three quarters of 2016,” according to a Seeking Alpha analysis of XLE.
The outperformance in RYE may be explained in its alternative indexing methodology. As opposed to traditional beta-index ETFs, like XLE that reflects a cap-weighted index like the S&P 500 Energy Index, the Guggenheim Energy ETF equally weights its components so that smaller companies have a larger tilt in its underlying portfolio.
As we have witnessed this year, the rally in energy stocks on the back of rising crude oil prices helped smaller midsized companies outperform the more cumbersome large-cap segment.
“Another key factor that will help improve the performance of energy related companies is the potential for less costly regulation. The combination of a Republican president and Republican controlled House of Representatives and Senate increases the chance of energy regulations becoming more business-friendly for the energy sector,” according to Seeking Alpha.
For more information on the energy sector, visit our energy category.