Shorts Avoid Energy ETFs As Sector Slumps

Investors have heard plenty of this this year: The energy sector is the worst-performing group in the S&P 500. Exchange-traded funds, such as the Energy Select Sector SPDR XLE are highlighting that weakness.

XLE, the largest equity-based energy ETF by assets, is down almost 10.1 percent year-to-date and resides about 13.7 percent below its 52-week high. Either way, XLE and some its cap-weighted rivals meet the definition of a correction.

Contemplating Energy

Obviously, investors considering ETFs such as XLE need to consider oil prices, but an often used contrarian indicator is lacking from the equation for energy stocks and that does not bode well. Data suggest short sellers are not flocking to the sector as its declines. Short sales data can be used as a contrarian indicator because large short interest in a stock that suddenly rises forces short covering, thereby driving the price even higher.

“While the former has occurred to some extent, as evidenced by the fact that the largest energy sector ETF, the Energy Select Sector SPDR Fund (XLE), extended its year to date underperformance against the S&P 500 past the 15 percent mark; short sellers are so far staying on the sidelines during this period of volatility,” said Markit in a recent note. “The last month has seen global energy shares register only a 3 percent increase in the sector’s average percent of shares outstanding on loan.”

Interestingly, XLE has seen year-to-date inflows of almost $819 million and some of that total could be attributable to short sellers. When traders short ETFs, new shares must be created for them to borrow, thereby creating inflows to the shorted ETF.

In Context

Based on that, year-to-date inflows of barely more than $68 million to the SPDR S&P Oil & Gas Exploration & Production ETF XOP confirm tepid short interest in the energy patch because XOP is often one of the most heavily shorted sector ETFs.

Other data points confirm energy sector interest is currently well below previous highs.

“Average shorting activity across all global energy firms has ticked up somewhat from the recent lows set over January; bearish bets are still way off the levels registered during the height of last years’ volatility,” added Markit. “In fact the current average short interest across these 700 plus energy firms whose shares are freely available in the securities lending market, 3.3 percent of shares outstanding, is still a quarter lower than that seen in February of last year; when oil prices hit their lows.”