The Energy Select Sector SPDR (XLE) is widely used to invest in energy stocks, especially in the age of the exchange traded fund (ETF) portfolio. Many technicians will do sector performance analysis using this fund as on the S&P Sector ETF chart at Stockcharts.com (here). The problem with this ETF is that it is capitalization-weighted in which the top two stocks – Exxon and Chevron – represent 30% of the entire fund. The performance of these two stocks has held the sector back, masking the true and stellar performance of energy stocks this summer.
Top XLE Holdings
Source: Bloomberg
If you’ve been an aggressive investor watching small cap stocks this summer, you already know that energy has been one of the best sectors to be in. This continues to hammer home the two key points I’ve been making since April: cyclicality and momentum. The real story this summer wasn’t the consolidation in stocks – it was the rotation into cyclical and momentum stocks. Location is to real estate what rotation is to the stock market.
Rotation, Rotation, Rotation!
Exxon Mobil is up 0.52% year to date after suffering a decent correction in the wake of its second quarter earnings. While Exxon is one of the most efficient allocators of capital in the industry, focusing on profitable projects, it continues to have a hard time with growth. It’s not as easy for Exxon to increase production like it may be for Apple. Exxon can’t just plop a factory wherever it wants. And right now, investors want growth over stability as risk appetites have improved this year. You also have to think of energy production companies as liquid warehouses. To grow, you need more product being restocked on the shelves than is going out; otherwise, you have reserve issues. That’s a pretty tough thing to do when you’re Exxon’s size and you already have some of the most profitable fields.
Here is a performance chart of various energy ETFs since mid-April when cyclical stocks began to perform well all due to the rotation out of non-cyclical stocks into cyclical stocks, i.e. industrials, materials, consumer discretion, and energy. Looking at the chart, note the huge divergence in performance between the various energy ETFs since Exxon’s second quarter reporting on August 1st. XOM was down almost every day after that release and at nearly 15% of XLE, that’s really going to hurt performance.
Energy ETF Performance
Source: Stock Charts
When Exxon purchased XTO Energy for $41 billion, natural gas was trading near $9 per million British thermal units. It closed Thursday near $3.58 per million British Thermal units. So why are so many natural gas producers performing so well in the past couple of months? When Exxon was steering towards natural gas, they were steering away from crude oil. In addition, there’s a new “technical renaissance” as EOG has coined it in frac technology.
EOG Resources (EOG) has focused the stimulation of the reservoir much closer to the wellbore instead of fracturing far away. The new system of fracing has improved drilling dramatically. Many other companies are trying the new technology or variations of it like WLL, CLR, XEC, NFX, and HK. And some appear to be having immediate beneficial results in production.
Sentiment has turned sour on Exxon Mobil causing a disproportionate impact on XLE, which has underperformed and deceptively depicts a sector that isn’t doing so well. Just the opposite, there are more companies basing – consolidating sideways for long periods of time – and rising out of bases in energy than in any other sector I’m watching right now. Don’t let Exxon and the XLE fool you.
