The Bearish Case On A Big Energy ETF

The Energy Select Sector SPDR XLE, the largest equity-based energy exchange traded fund, is higher by 16 percent this year.

XLE's strong start to 2019 underscores the energy sector's redemption story this year, but not all analysts are impressed.

What Happened

In a new research note, AltaVista Research tagged XLE an “Avoid” rating, by far the worst rating the research firm assigns to the 11 sector SPDR ETFs.

“Not worthwhile for most investors,” said AltaVista. “A rating of AVOID is assigned to ETFs with ALTAR Scores in the lowest quintile (the bottom 20%) of their category. Often, funds in this category consist of stocks with little if any history or expectation of profitability, and as a result our fundamentally-driven analysis may not be relevant.”

Why It's Important

XLE allocates almost 42 percent of its combined weight to Exxon Mobil Corp. XOM and Chevron Corp. CVX, the two largest U.S. oil companies, so a bearish recommendation on XLE isn't exactly a ringing endorsement of those stocks.

Exxon and Chevron are two of the 18 members of the Dow Jones Industrial Average that are up at least 10 percent this year, indicating that AltaVista's bearish view on XLE runs contrary to broader sentiment on energy stocks. As one example, Chevron, XLE's second-largest holding, closed just under $125 on Tuesday, well below the average analyst price target of $137.54.

AltaVista's bearish thesis on XLE could be tested when Exxon and Chevron report first-quarter earnings, reports that usually come within a day of one another. During the first quarter, all S&P 500 sectors saw downward earnings revisions, but energy was one of the worst offenders.

“In fact, the first quarter marked the largest percentage decline in the bottom-up EPS estimate during a quarter since Q1 2016 (-9.8%),” according to FactSet. “At the sector level, all 11 sectors recorded a decline in their bottom-up EPS estimate during the quarter, led by the Energy (-34.0%).”

What's Next

AltaVista highlighted those revised estimates.

“Estimates for this year are down almost 30% in the past six months (though they stabilized in the last month) reflecting a tendency for shale producers to ramp up production on any spike in prices,” said the research firm. “As a result investors should be prepared for average oil prices to stay "lower for longer." While we rate the Energy sector lower than any other, the sell-side rating has grown much more bullish recently, and now exceeds that for the S&P 500.”

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