2023-12-05 15:43:09 ET
Summary
- Energy stocks, including the Energy Select Sector SPDR® Fund ETF, have been weak recently and are likely to remain so.
- The XLE ETF is not a diversified fund and is heavily reliant on energy prices, which are currently weak.
- The two largest holdings in XLE, Exxon Mobil and Chevron, are not cheap enough to warrant investment in the fund.
Energy stocks were the darling of Wall Street in 2021, with crude oil flying higher, in addition to other forms of energy. Energy tends to trade independently of the other major sectors, most of which trade with economic strength (or weakness). Energy has been weak recently, and based on what I'm seeing, is likely to remain as such.
In this article, we'll take a look at the Energy Select Sector SPDR® Fund ETF (XLE), a fund that I think investors should steer clear of at the moment. I see the risk of XLE's price action as leaning downward.
What is XLE?
XLE, in short, is a massive, $37 billion fund that holds a relatively small number of energy stocks. It tracks the energy sector of the S&P 500, so it's market cap-weighted, and tracks companies in the oil, gas, consumable fuel, energy equipment and services industries. Given this, it is not a diversified fund; it's a bet largely on energy prices that happen to pay a nice dividend yield.
Seeking Alpha
We can see here that two energy conglomerates at the top make up almost 40% of the fund, with the other 24 holdings making up the remaining three-fifths. Indeed, the top 10 holdings are 72% of the fund. Again, not a low-risk/diversified fund.
To be fair, XLE is extremely cheap to own, with an expense ratio of just 10bps. That means it is doing its job as a concentrated, cheap-to-own fund, but in the current environment, I don't think that's enough.
Chart leaving something to be desired
Let's take a look at the daily price chart of XLE, and when I look at this, I have a hard time being bullish.
We can see there is potentially strong resistance in the area of $85/$86, which was resistance earlier this year, and later became support. That support failed, so it's now resistance as well. In addition, the moving averages are both firmly trending lower, with the fund right at the 20-day exponential moving average. We may see the fund clear that moving average, but I would be very surprised to see it clear the blue 50-day simple moving average, which is currently only a couple of bucks ahead of the current price, but rapidly descending.
Momentum is weak as well, with the PPO and 14-day RSI both in bearish territory, and showing no signs of strength. The accumulation/distribution is making new lows, which simply means during the trading day, there's more selling than buying. Again, not indicative of a bullish move or even impending trend change.
Now, I'm fully aware that XLE represents much more than just exposure to crude oil, but check out the 50-day correlation of XLE to that of the price action of crude oil (CL1:COM).
It's always extremely positive, and for now, sits at 0.89. That means XLE and crude oil trade are essentially in lockstep, so let's take a look at crude's chart to get some clues on XLE.
Crude looks similar (unsurprisingly), and the characteristics are largely the same.
I won't go through them again because they're the same. But my point is that I don't see a lot of reason to be bullish on crude oil at the moment, which means I can't be bullish on XLE. Energy bulls need to make a lot of progress on the crude oil chart before XLE will show signs of life, and I don't even see green shoots on that front.
OPEC cuts not working
We know crude oil is mostly controlled by a cartel, and that cartel is trying to raise crude oil prices by cutting production . The thing is, the market has largely ignored the production cuts. Sometimes production cuts see prices rise, and sometimes they don't; this one is, thus far, firmly in the latter category.
There are fears of recession popping up all over the developed world, and maybe they come to fruition and maybe they don't, but right now, that's proving enough to keep a lid on crude prices, and that's all that matters. Oil is one of the most sensitive things I can think of to geopolitical risk, so this could all change tomorrow. But for now, based on the evidence I see, crude oil is simply too weak for the XLE.
The thing is that after a long downtrend, you'd hope the fund was cheap. To my eye, it isn't anywhere near cheap enough. Given that XLE is an income fund, we can use the dividend yield to help value it, and right now, I'm not impressed.
The yield is 3.6% now, which is ~2X that of the S&P 500 (SP500), but you can also buy US Treasuries and get a much better yield. Not only is it better, it's tax-advantaged and doesn't carry earnings risk. That's a preference each investor must make for themselves, but my point here is that the yield doesn't look great from a valuation perspective, or against other income alternatives.
Finally, from a valuation perspective of the two largest holdings, I see a mixed bag.
Valuations have come way down since the summer, and that's made the bull case easier to make. However, Exxon Mobil (XOM) and Chevron ( CVX ) were simply too expensive earlier this year, so this selloff has only brought us back to fair value. Exxon is about 11X forward earnings, Chevron is at ~10X. Chevron is slightly cheaper than Exxon against historical valuations, but they're both essentially at fair value. In other words, recent selling hasn't made these stocks (or the fund itself) cheap; it's simply made them so they're no longer too expensive.
I point this out because these two stocks are about 40% of the fund, so the way they trade is critical to the XLE. With crude oil unable to find a bid and these two stocks nowhere near cheap, I don't see a lot of reason to want to own XLE.
Given all of this, I'm placing a sell on XLE. I don't see signs of life from crude oil, I think XLE is in a downtrend until proven otherwise, and the two largest holdings - Exxon and Chevron - are nowhere near cheap enough for a long-term downtrend in energy prices. The yield is fine, but again, not indicative of a fund that's cheap enough. It's a sell.
For further details see:
XLE: Energy Stocks Showing No Signs Of Life