Overweight A Struggling Energy ETF? One Research Firm Says Yes

Down 13.3 percent year-to-date, the Energy Select Sector SPDR (NYSE:XLE) is the worst performer among the nine sector SPDRs and that dubious battle is not all that close as the second-worst member of that group, the Materials Select Sector SPDR (NYSE:XLB), is off 10.3 percent.

XLE's doldrums have not stopped investors from pouring into the fund, nor has the largest equity-based energy exchange traded fund's lethargy prevented some analysts from being bullish on the fund. In a note out Tuesday, AltaVista Research reiterated an Overweight rating on XLE.

ETFs earning that rating from AltaVista show above average appreciation potential. A rating of OVERWEIGHT is assigned to funds with ALTAR Scores above 8.0% but less than 11%. Typically, funds in this category consist of stocks trading at attractive valuations and/or having above-average fundamentals, according to the research firm.

With an ALTAR score of 9.3 percent, XLE is the only one of the nine SPDRs with a score above 8 percent. However, neither XLE's ALTAR score nor weak oil prices nor the energy's sector laggard status mean XLE is inexpensive on valuation. In fact, even when accounting for slumping oil prices, the energy sector is richly valued relative to the broader market.

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The energy sector is expected to post an earnings contraction of almost 60 percent this year, but XLE's estimated 2015 price-to-earnings ratio is 25.5 compared to 16.3 for the S&P 500, according to AltaVista data. Only the Consumer Discretionary Select Sector SPDR (NYSE:XLY) and the Consumer Staples Select SPDR (NYSE:XLP) also have estimated 2015 P/E ratios of close to 20.

These less-than-positive factors have not prevented investors from adding $2.2 billion in new assets to XLE this year. Said differently, XLY and the Health Care Select Sector SPDR (NYSE:XLV), the only two sector SPDRs with positive year-to-date showings, have taken in just over $2.2 billion combined. In fact, XLE's shares outstanding tally has surged 60 percent over the past 12 months, according to AltaVista data.

Interestingly, XLE is not the object of short sellers' desires it was earlier this year. Twenty-six percent of XLE's shares outstanding are sold short, a percentage surpassed by four of the other sector SPDR ETFs.

Profit expectations are falling again after they appeared to stabilize in recent months, and EPS are now forecast down by more than half. On such depressed earnings the P/E ratio naturally appears elevated, but stocks in the sector look attractive on other valuation metrics like P/BV especially if the lousy Return on Equity figures forecast for this year and next is temporary, rather than a 'new normal' reflecting abundant new supplies from shale, said AltaVista.

Add to that, historical data suggest XLE makes for the ideal sector ETF should the Federal Reserve raise interest. XLE was the best of the nine SPDRs during the Fed's 2004 to 2006 tightening cycle and energy stocks displayed similar bullishness during previous tightening cycles.

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