Monday, December 22, 2014

Fed Patience makes for Happy Holidays

Just when investors were starting to wonder if there would only be coal in their stockings this Christmas, Santa Yellen helped deliver some much needed cheer with her announcement on Wednesday that the Federal Reserve will be “patient” when it comes to raising rates in 2015 or 2016 or whenever.  Coupled with a slight drop in inflation expectations, equities were off to the races in the second half of the week and offering underperforming large cap managers everywhere a reason to buy with both hands before the Santa Rally leaves them behind.  And with risk back on the menu last week, it was understandable that the low volatility sectors we discussed here last week such as Financials Select Sector SPDR Fund (XLF) and Vanguard Information Technology Sector ETF (VGT) both lagged the broader S&P 500’s 3.4% move for the week.

Perhaps the least surprising move was the strong advance made by the Energy Select Sector SPDR Fund (XLE), up 9.53% for the week including a jaw dropping 3.2% advance on Friday as the major energy benchmarks managed strong advances on “Quadwitching” day.  While select energy names have appeared near the top of our screener results for some time now, with both Brent and West Texas down around 50% since June as concerns on overproduction and slowing global demand, energy investors have found themselves pushed into a previously undiscovered level of misery.  It might be natural to see energy stocks recoupling with broader equities after Wednesday’s FOMC announcement but prior to this week’s rally, previous attempts to buy into XLE with the assumption that a rebound or even dead cat bounce was way overdue were met with more selling and big gap downs, so we have to ask whether this rally that began on Tuesday is more than simple short covering?

First. we looked at the fund names that made the biggest gains last week and while the broad XLE’s performance was impressive, it paled in comparison to the gains in the oil services and equipment sector with SPDR S&P Oil & Gas Equipment & Services ETF (XES) up 14.35% for the week while the larger Market Vectors Oil Services ETF (OIH) was up over 11%.  The strong performance came from the start of merger mania as Talisman Energy announced on Tuesday it was to be bought out by Repsol for $8.3 billion.  While not included in most energy ETFs, the stock had been trending higher since 12/11 and helped spark a rally in other names that could become potential takeover targets such as Nabor Industries, up 36.3% last week and Denbury Resources (also up 30%), both of which have seen their daily volume more than double compared to their three month averages.

So besides playing for position in advance of a potential merger, is there anything else that could offer more lift to the energy sector?  Energy names were well represented on our list of biggest ETFG Quant Behavorial score changes as improving short-term price momentum combined with still high short interest with the First Trust Energy AlphaDex Fund (FXN) seeing its behavioral score climb nearly 80% last week!  And despite the strong week, energy stocks still offer among the best relative values in the market with trading at a P/E multiple of 12.33 compared to 14.63 for XLE and 17.60 for the broader SPDR S&P 500 ETF (SPY).

Thank you for reading ETFG Perspectives!

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