With fourth-quarter earnings season here, the time is right for investors to evaluate exchange traded funds for sectors that have the potential to deliver upside surprises. Some of those surprises could come courtesy of the energy sector and the Energy Select Sector SPDR (NYSEArca: XLE), the largest equity-based energy ETF.
With the arrival of the first quarter, an interesting dynamic is at play. Energy stocks historically start gaining momentum in the middle of the first quarter with that trend having the potential to last deep into the second quarter. Rivals to XLE include the Vanguard Energy ETF (NYSEArca: VDE), iShares U.S. Energy ETF (NYSEArca: IYE) and the Fidelity MSCI Energy Index ETF (NYSEArca: FENY).
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.
“Energy should have the best “upside” in terms of Q4 ’16 earnings growth simply because I suspect the energy companies have been shrinking their P/Ls the last 8 quarters, which should give the sector nice leverage as expected Q4 ’16 revenue growth for the energy sector is expected to be the strongest in 2 years,” according to a Seeking Alpha analysis of energy ETFs.
Energy companies were largest contributor to the earnings decline for the S&P 500 in the third quarter, the stabilizing crude oil prices and potential production cutbacks from major oil producers could help support sector-related exchange traded funds.
Oil services ETFs, such as the VanEck Vectors Oil Service ETF (NYSEArca: OIH) and the SPDR Oil & Gas Equipment & Services ETF (NYSEArca: XES), have also been solid performers and have earnings upside surprise potential.
Earlier this month, Credit Suisse upgraded several oil services providers, including some of the names found in OIH, the largest oil services ETF, and XES.
“Cash flow and free cash flow should also be a positive story for the sector. Don’t forget it was Q1 ’16, where basically the profits for the entire energy sector were wiped out, with the drop in crude oil from $40 in November ’15 to $28 by mid-January ’16; so the sector should see a few quarters of potential outperformance relative to the rest of the market,” notes Seeking Alpha.
For more information on the energy sector, visit our energy category.