Investors Are Bottom Fishing With Energy ETFs

The Energy Select Sector SPDR (ETF) (NYSE: XLE), the largest equity-based exchange-traded fund tracking the energy sector, was the worst performing of the nine legacy sector SPDR ETFs in each of the past two years.

Fortunately for XLE, three weeks into 2016, the ETF is avoiding that ominous fate even with a 11.9 percent year-to-date loss. Believe it or not, the Materials Select Sector SPDR (NYSE: XLB) has been even worse, clocking in a 2016 loss of 14.8 percent.

Oil's ongoing weakness is not chasing investors from oil ETFs. In fact, that continuing weakness is emboldening some to keep betting on an oil rebound.

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The Oil Impact

Year-to-date, investors have added nearly $464 million in new money to XLE. Among the nine SPDRs, only the Utilities SPDR (ETF) (NYSE: XLU) and the Consumer Staples Select Sect. SPDR (ETF) (NYSE: XLP) have seen larger year-to-date inflows.

One interesting element to XLE's inflows is that the influx of new capital to the ETF comes amid declining short interest, meaning investors are buying XLE wagering that the ETF is poised to go up.

When short sellers borrow shares of an ETF to short, new shares are created, giving the impression that assets under management are rising. When those short sellers cover, the ETF's asset can decline. XLE's short interest has been steadily declining since the fourth quarter of 2014.

“An analysis of the largest energy sector ETF, the Energy Select Sector SPDR Fund [XLE], vs. its short interest percentage indicates flows are coming from ETF purchases and not from short positioning. This typically suggests investors are positioning for a bottom in the energy sector,” said State Street Vice President David Mazza in a recent note.

Earnings Improvement On The Horizon

The good news for ETFs such as XLE is that although average oil price forecasts for this year are still well below the high market prices seen a couple of years ago, earnings are expected to improve.

At the very least, XLE's holdings should see decreased earnings contractions this year. Dow components Exxon Mobil Corporation (NYSE: XOM) and Chevron Corporation (NYSE: CVX), the two largest U.S. oil companies, combine for 34 percent of XLE's weight.

“The energy sector had a tough year in terms of performance with the S&P Energy Select Sector Index down about 21 percent in 2015. Despite this, energy ETFs have attracted the largest amount of inflows this year, outpacing the high growth health care and consumer discretionary sectors,” added Mazza.

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