It is not unreasonable to think that when a sector lags other groups and the broader market that its valuations may start to become appealing. However, that is not the case in the energy patch this year. Energy, the seventh-largest sector weight in the S&P 500, is the worst-performing sector in the U.S. this year and it is also expensive.
The Energy Select Sector SPDR (NYSEArca: XLE), the largest exchange traded fund dedicated to energy equities, is down 10.1% year-to-date. 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.
However, investors will not find attractive valuations on lagging energy stocks. At least not at the moment.
“At nearly 28 times forward earnings, the sector’s forward price-earnings ratio is significantly above the second most richly priced sector, consumer discretionary. Its trailing price-to-earnings ratio is 33 times, second only to real estate among the 11 sectors,” reports CNBC.
Valuation concerns for the energy sector come even as the sector is featured prominently in an array of value ETFs. However, the sector looks more like a value trap than a legitimate value play over the near-term.
“This high price as compared with expected earnings comes despite a major comeback for energy profits; the sector is on track to report 790 percent net income growth this quarter from the first quarter of 2016, according to FactSet estimates. Energy is also reporting the highest year-over-year earnings growth of any sector, according to FactSet,” according to CNBC.
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. Some traders are not convinced and caution about betting on an energy sector rebound.
Some technical analysts believe that if XLE drops below $65, selling pressure could intensify, sending the big energy ETF lower in the process.
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.
For more information on the oil market, visit our oil category.