Energy ETFs are outshining the S&P 500, but it’s not just because of the oil rally

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As the broader U.S. stock market continues its sluggish start to September, the once struggling energy sector is again grabbing attention with exchange-traded funds that invest in energy stocks surging and pulling in outsized flows this past week after Saudi Arabia and Russia surprised the markets by curtailing oil output through the end of year, pushing crude-oil prices to their highest levels of 2023. 

The Energy Select Sector SPDR Fund
XLE,
which is seen as a proxy of the energy sector of the S&P 500
SPX,
attracted inflows of over $326 million and jumped 2.7% in the past five trading days to Wednesday, according to FactSet data. The United States Oil Fund LP
USO
recorded a total inflows of $110.6 million and surged 6.6% in the past week, while the SPDR S&P Oil & Gas Exploration & Production ETF
XOP
brought in $44 million of capital and was up 2% over the same period, according to FactSet. 

Oil futures were slightly lower on Thursday after prices for U.S. and global benchmark crude contracts marked fresh settlement highs for the year in the previous session. West Texas Intermediate crude for October delivery
CLV23,
-0.62%
fell 67 cents, or 0.8%, to settle at $86.87 a barrel on the New York Mercantile Exchange, while the November Brent crude
BRNX23,
+0.14%
fell 18 cents, or 0.2%, to $90.42 a barrel on ICE Futures Europe. 

See: Energy stocks getting ready to take the lead again after crude’s August bounce, says strategist

The recent bounce in oil prices, which started in late August as positive economic data eased some U.S. recession concerns, is partially fueling the upswing in energy stocks, said Paul Baiocchi, chief ETF strategist at SS&C ALPS Advisors. However, the actual uptrend in energy shares started much earlier as the fundamentals of energy-related companies improved dramatically over the course of the past few years, Baiocchi said. 

“Historically, energy has been the most vulnerable sector in the S&P 500, so investors have to go in with eyes open in the sense that it’s going to be volatile and always has been and likely always will be,” Baiocchi told MarketWatch in an interview on Wednesday. “I think what investors are waking up to is the realization that the sector now looks a lot different than it did five, six years ago.” 

Baiocchi said the balance sheets for some “legacy” U.S. energy companies have gotten “much better” because firms have been minimizing their costs on new projects due to the regulatory backdrop and transition to renewable energy. “When you’re in an environment where you’re spending way less and growing capex [capital expenditures], while revenues are going up because energy prices are going up, then you will have more free cash flow to focus on de-leveraging and share buybacks and dividends,” he said. 

The S&P 500 Energy Sector
XX:SP500.10
rose for nine consecutive sessions on Thursday, on pace for its longest winning streak in 14 years, according to Dow Jones Market Data. But with a merely 3.4% gain year-to-date, the sector was still struggling to match its blowout performance last year when it rallied nearly 60% to become the only segment of the large-cap index to end 2022 with gains.

Baiocchi thinks the recent bounce in energy stocks may also reflect the rotation in the stock market away from megacap technology and growth stocks toward the sectors that “tilt a little more value.” 

The S&P 500 Communication Services Sector
XX:SP500.50
has advanced over 43% year to date, while the Information Technology Sector
XX:SP500.45
has jumped over 40%, according to FactSet data. However, the tech rally started to lose momentum in August with the Nasdaq Composite
COMP
posting its biggest monthly decline in 2023.

Savita Subramanian, head of equity and quantitative strategy at BofA Global Research, said her team is bullish on value stocks and expect energy and financials sectors to outperform and “hold up the rest of the market,” they wrote in a Thursday note.

“A potential macro inflection argues for value outperformance from here. We expect 2Q to mark the trough in year-over-year EPS [earnings-per-share] growth,” which points to a value comeback, they said. “Value is still cheap and under-owned by active funds.”

See: Why crude-oil rally can’t be ignored by investors — or the Fed

As usual, here’s your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good…

…and the bad

New ETFs

• F/m Investments LLC Wednesday announced the launch of the F/m Opportunistic Income ETF
  XFIX,
  an actively managed ETF which invests in investment grade and high yield corporate and municipal bonds, U.S. Government and agency securities, mortgage-backed securities and preferred stocks, and specialty issues, including $25 par value baby bonds.

• iM Global Partner and Polen Capital have partnered to launch the Polen Capital Global Growth ETF
  PCGG
  on August 30, which focuses on companies with high returns on capital and double-digit earnings growth, holding them over the long term with little portfolio turnover.

Weekly ETF Reads