The Energy Sector Isn't The Big Fish It Used To Be

With the help of a 3.66% rally this week, the Energy Select Sector SPDR XLE, the largest equity-based exchange traded fund, is back in the green on a year-to-date basis, but it's still one of the worst-performing groups in the S&P 500 this year.

What Happened

Moreover, energy's malaise, one that has involved several substantial slumps in recent year, is making the sector in after thought in the S&P 500. Entering Thursday, the SPDR S&P 500 SPY allocated just 4.43% of its weight to energy stocks.

Only three sectors – utilities, real estate and materials – have smaller weights in the benchmark domestic equity gauge than does energy. That after Exxon Mobil XOM, the largest U.S. oil company and XLE's top holding, recently fell out of SPY's top 10 holdings for the first time ever.

Why It's Important

Indeed, energy's fall from index grace has been palpable.

“Between the calendar years 2007 and 2013, the Energy sector’s weighting ranged between 10%-13% of the S&P 500 Index, but at the end of 2018 it was 5.3% according to Howard Silverblatt, a senior Index Analyst at S&P Dow Jones Indices,” said CFRA Director of ETF & Mutual Fund Research Todd Rosenbluth in a Wednesday note.

Another unfortunate result of energy's waning influence in broad market indexes is that investors may be ignoring improving free cash flow in the sector.

“Ironically to CFRA equity analyst Stewar Glickman, based on 2019 and 2020 Capital IQ consensus estimates, it looks like many production companies are going to deliver strong free cash flow, but that improvement is seemingly falling on deaf ears, given Energy’s dwindling share of overall market capitalization,” said Rosenbluth.

As one example of that improving cash flow, Bank of America analyst Doug Leggate said earlier this week that investors aren't giving Exxon enough credit on the cash flow front and he's forecasting major upside for the Dow component.

What's Next

Investors looking for higher energy exposure than is found in SPY without the commitment of an ETF like XLE may want to consider value funds. As Rosenbluth points out, the S&P 500 Value Index has an energy weight of 6.5% and some value ETFs have even larger weights to the sector than that.

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