The energy sector looks like an enigma to some investors. It was the worst-performing group in the S&P 500 last year, but it’s also the only sector that’s legitimately undervalued.
Investors willing to bet on a value resurgence and an economic reopening that will stoke higher crude prices can consider exchange traded funds, such as the Energy Select Sector SPDR (NYSEArca: XLE), the largest equity-based energy exchange traded fund.
XLE seeks to provide investment results that correspond generally to the price and yield performance of publicly traded equity securities of companies in the Energy Select Sector Index, which includes securities of companies from the following industries: oil, gas, and consumable fuels; and energy equipment and services.
Recent “gains have been broadly distributed across sectors, but energy has been the star this quarter, rising 29.02%. Yet, even after this surge, at a price/fair value of 0.71, we continue to view the energy sector as the most and now the only sector that remains undervalued,” according to Morningstar.
Examining XLE for 2021
Some data points indicate sell-side analysts remain bullish on energy stocks, including some XLE components. Valuation may be one reason why. The recent sell-off may have opened up a potential buying opportunity for bargain hunters, especially in the oversold energy sector.
The energy market experienced a dreadful year in 2020, as this was the first time that traditional energy exchange-traded funds fell and renewable energy ETFs rose.
The traditional energy market has been shaky ever since prices fell in 2015 when a glut of petroleum flooded world markets. Supply and demand were supposed to come into balance this year, but the pandemic crushed global demand when the world effectively shut down. Crude-oil prices are hovering around $45 a barrel now, about the mid-point for where prices have traded for the past five years, but a far cry from the $100 a barrel they were trading at 10 years ago.
UBS analysts said in their 2021 outlook that this year was the biggest shock to the energy complex since World War II, noting “that appreciation and destruction of capital at such size is really giving every investor pause for thought.”
“Value stocks should benefit from the strong economic rebound in 2021 as economic activity normalizes. Across sectors, we continue to expect energy stocks to outperform the broader market. Through Dec. 21, oil prices have risen to $48 per barrel from $39 at the end of the third quarter, and we project oil will reach $55 per barrel by the middle of this economic cycle,” notes Morningstar.
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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.