Preparing For An Energy Rebound With A Familiar ETF

Down 5.8 percent year-to-date, the Energy Select Sector SPDR XLE is not the worst performer among the sector SPDR exchange traded funds. That dubious distinction belongs to the Financial Select Sector SPDR XLF. However, XLE was the worst-performing SPDR in 2014 and 2015.

While sector exchange-traded funds are performing worse than XLE, energy ETFs do face dividend issues, and those issues are not pleasant. Last year, when the energy sector was the worst performing group in the S&P 500, energy stocks accounted for the bulk of the negative dividend actions in the benchmark U.S. equity index.

Negative dividend action is one issue plaguing XLE and rival energy ETFs. Low oil prices and reduced capital spending by oil companies, exclusive of dividends, are others. Still, investors willing to wager that the worst has passed the energy sector might want to consider making that bet with XLE, but that bet won't be bump-free.

“For example, over the past 10 years, this ETF's standard deviation of returns of 22.0% is far higher than the 15.1% posted by the S&P 500. And XLE's three-year standard deviation of returns of 17.2% also far eclipses the 10.9% logged by the broad benchmark. Within this fund, some of the greatest volatility can be found in the performance of energy exploration and production firms and oil-services companies,” said Morningstar in a recent note.

Energy equipment and services stocks account for 18.6 percent of XLE's weight. Dow components Exxon Mobil Corporation XOM and Chevron Corp. CVX, the two largest U.S. oil companies, combine for nearly 35.5 percent of XLE's weight.

Perhaps bolstering the case for energy ETFs, such as XLE, is valuation. While the energy sector's price-to-earnings ratio is not overwhelmingly compelling by virtue of the group's contracting earnings, the sector's price-to-book ratio resides around multi-year lows.

Beyond valuation, myriad factors affect energy ETFs. In the near-term, that includes the desire of major oil producing nations to move forward with production cuts. That is something Saudi Arabia and Russia, among others, have greeted in tepid fashion. Even if those countries do scale back output, there can be no guarantees U.S. shale producers will follow suit.

Of course, it would help energy stocks if the broader market mounted a legitimate rally.

“Over the years, XLE's diversification potential seems to have been eroding. Over the trailing 15-year period, XLE has been 66% correlated with the S&P 500. However, over the trailing 10- and five-year periods, its correlation to the S&P 500 has increased to 72% and 78%, respectively,” said Morningstar.