The Energy Select Sector SPDR (NYSEArca: XLE), the largest exchange traded fund dedicated to stocks in the S&P 500’s seventh-largest sector, is down 9.5% year-to-date, but some market observers believe the energy sector is poised to end its slump.
Some analysts believe the energy sector can deliver upside for investors later this year. Energy is one of a small amount of sectors that still trades at a noticeable discount relative to long-term averages. Additionally, the energy sector is usually among one of the largest sector weights in value ETFs, underscoring the point that the group is attractively valued relative to some defensive sectors, which trade at lofty multiples.
Energy’s earnings drag is evaporating as S&P 500 energy earnings are expected to be only slightly negative for the fourth quarter and offer significant upside potential moving forward in 2017. XLE currently resides near its lowest levels since prior to the U.S. presidential election in November.
“You still have supply growth that’s overhanging the market, and the OPEC tailwind is being overshadowed by that,” David Seaburg, head of equity sales trading at Cowen and Co., said in an interview with CNBC, “referring to the tug of war between OPEC production cuts and increasing U.S. supply.”
Rig counts have recently ticked higher and with credit and earnings issues improving for some U.S. shale drillers, those companies may seize the opportunity to exploit higher pricing in the near-term. Global energy ETFs are struggling, too. Just look at the iShares Global Energy ETF (NYSEArca: IXC), which is also lower on a year-to-date basis.
Rivals to XLE include the Fidelity MSCI Energy Index ETF (NYSEArca: FENY) and the Vanguard Energy ETF (NYSEArca: VDE), which are two of the least expensive energy sector ETFs.
Domestic politics could prove to be a catalyst for the energy patch as well.
Larry McDonald, of ACG analytics, told CNBC “that many energy companies pay high tax rates, which means that ‘as the perception of tax reform comes back in the next couple of months, we could see a lot of upside in the XLE.’”
The challenge for energy equities is that some oil market observers see more declines coming for crude. Oil traders are concerned over how fast U.S. shale oil producers will increase production to capture the rising prices.
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