Virus Sends Lagging Energy ETFs Lower

The coronavirus certainly hasn’t had the impact on markets that many had expected. The virus, which has infected tens of thousands and killed more than 1,300, is deadlier than SARS, but you wouldn’t know it from looking at equities.

The S&P 500 is at record highs, as is the MSCI World Index. Even Chinese equities haven’t fared all that poorly. The largest China ETF on the market, the iShares MSCI China ETF (MCHI), is up 1.2% year to date.

By and large, stock investors have been looking through the worst of the coronavirus, believing that its impact on global economic growth will be short and shallow.

But not all assets have reacted so nonchalantly to the virus. Oil has been taking it on the chin ever since the coronavirus entered the scene. U.S. benchmark oil futures sagged by more than 15% so far this year, pushing the United States Oil Fund LP (USO) down by a similar amount.

WTI Crude Oil Prices Retreat 

Oil Demand Sags For First Time In A Decade

As the world’s largest consumer of commodities, even a temporary economic setback for China can have deep and lasting reverberations in the commodity markets. Ned Davis Research went as far as to say that the coronavirus is “a true black swan” for the oil and energy markets.

According to the International Energy Agency, oil demand may fall by nearly half a million barrels per day in the first quarter, largely due to the widespread shutdown of China’s economy. If it comes to pass, that would mark the first quarterly contraction for oil demand in 10 years.

Even before the virus, oil prices had been capped by the trade war, slowing global economic growth and surging U.S. production—though there was some hope that the U.S.-China trade truce would finally turn the market around. The virus throws a monkey wrench into those hopes.

To make matters worse, OPEC and Russia have been unable to reach an accord to cut production and remove some of the excess barrels on the market.

New Lows For Energy

With little hope for a quick turnaround in oil prices, investors have all but abandoned the energy sector. Already a pariah, the sector has reached a new low in terms of sentiment and weighting within the broader markets.

The sector has a mere 3.8% weighting in the S&P 500, the lowest level in modern history. The Energy Select Sector SPDR Fund (XLE), the largest energy ETF, is trading at its cheapest level since 2016, when oil was only $26/barrel.

Energy is now a deep value play, and value plays are largely out of favor in the current market environment. That doesn’t mean the sector can’t outperform going forward, but to buy energy now is certainly a contrarian position.

On the plus side, because they are so beaten down, energy ETFs have juicy dividend yields. XLE, for example, is yielding 4.2%. That means you get a solid amount of income just for holding—much more than Treasuries can offer you.

Thus, in addition to value investors, income investors may find energy ETFs compelling at these levels.

Other Options

Another energy ETF worth considering is the Alerian MLP ETF (AMLP), a fund that holds energy infrastructure stocks and has a hefty yield of more than 9%.

For more exposure to smaller energy producers and less exposure to integrated oil companies, take a look at the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). It gives you a much smaller yield—1.9%—because it doesn’t have the Exxons and Chevrons of the world, but it also gives you higher-beta exposure to oil prices.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

For trading a quick bounce in oil prices, XOP will give you the biggest short-term bang for your buck. Traders can also use the aforementioned USO, which holds oil futures contracts, to make short-term trades in oil prices.

​Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2