Energy (as measured by Energy Select Sector SPDR ETF (NYSEARCA:XLE)) is the best performing major sector in the US market this year, up more than 8% vs. the 5.2% advance for the S&P 500 (INDEXSP:.INX). It had been a forgotten pocket of the equity market after last year’s poor performance, closing flat while the S&P 500 closed up 14% in 2012. But it’s off to a blistering start this year as WTI crude oil prices have rallied more than 5% in 2013.
How closely has XLE followed WTI oil prices over the last few years? Here is a three-year chart of front month WTI crude oil futures (red) vs. XLE (blue), showing the respective percentage change since Jan 2010:
Three-year chart of XLE vs. first month WTI oil contract, Courtesy of Bloomberg
The correlation is quite high, as evidenced by the chart. The two assets have moved in relatively close lockstep with one another – XLE is up 37% in this period, while front month WTI oil is up 31%.
The recent interesting tidbit in the price action has been that XLE has been particularly strong since Dec 31, signaling fund managers thirsting for energy shares above and beyond the market’s demand for oil as a whole. It seems that the rotation into energy to start 2013 is to make up for the underweight that many managers carried in 2012, given that energy was such an underperformer.
The strong performance in the energy sector stands apart from the other commodities, in both the equity and commodity markets. The materials sector (as measured by Materials Select Sector SPDR ETF (NYSEARCA:XLB)) is up less than 5% to start 2013, and precious metal miners are actually down in 2013 (as is gold).
XLE’s top-five components are Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), Schlumberger (NYSE:SLB), Occidental Petroleum (NYSE:OXY), and ConocoPhillips (NYSE:COP), all names with dividend yields between 1-4.5%. Excluding the one oil service name, SLB, the other four oil majors have P/E multiples between 9 and 12x, cheaper than the broader market.
Combine cheap multiples relative to the broader market, decent dividend yields, and fund rotations into the sector, and the prospects for large-cap energy in 2013 seem bright. The main potential hiccup in the bullish tableau would be a retreat in oil prices. For now, with the global liquidity spigot turned to Very High, market players are happy taking that risk.
This item by Enis Taner was originally published on RiskReversal.com
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