Energy ETFs Might Just Have More In The Tank

The energy sector is the best-performing segment in the S&P 500 this year. Additionally, Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX), the two largest U.S. oil companies, are two of the just 14 members of the Dow Jones Industrial Average that are up at least 10 percent year-to-date.

Energy Is Winning 2016

So explaining why the iShares Dow Jones US Energy Sector (ETF) (NYSE:IYE) is up nearly 18 percent this year, ranking as one of the better performing non-leveraged sector exchange-traded funds, is not particularly difficult. Of course, energy stocks and ETFs remain beholden to supply dynamics and the efficacy of action on that front by the Organization of Petroleum Exporting Countries (OPEC).

The OPEC plan is seen as a strategic shift by Saudi Arabia away from a battle for market share, said BlackRock in a recent note. Skepticism abounds on OPEC implementation. Still, we see less risk of a renewed oil price plunge and the potential for a gradual rise toward long-term equilibrium levels around $60 a barrel, where supply and demand are likely to find a better balance. A spike beyond that level is unlikely as some sidelined oil producers would then have incentives to ramp up production.

IYE and the energy sector could be drawing renewed interest as investors seek out what they perceive to be the last bastions of value in one of the longest bull markets in U.S. history.

Conversely, defensive, rate-sensitive sectors such as consumer staples and utilities are viewed as richly valued and vulnerable to pullbacks due to those frothy valuations.

Energy, The S&P500 And Rallies

Additionally, some market observers note that when the energy sector is such a small part of the S&P 500, as it is now, that has often led to lengthy rallies in the years after the group becomes one of the smaller weights in the benchmark U.S. equity index.

Higher oil prices would reinforce current market trends based on reflation: rising long-term bond yields and a shift out of perceived safer assets bond proxies and low-volatility stocks and into cyclical assets such as EM. Within energy equities, we favor quality and low-cost producers, added BlackRock.

Investors have added $32.5 million to IYE this year, bringing the ETF's assets under management to just north of $1.2 billion.

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