Energy Bears Retreat as Stocks Post S&P 500’s Best Rally

Energy stocks are handing U.S. investors the best gains this quarter and the options market is signaling the rally isn’t over.

Oil and natural gas producers are up 5.5 percent since the end of March, the most in the Standard & Poor’s 500 Index. Options on the Energy Select Sector SPDR Fund, an exchange-traded fund tracking the industry, are the cheapest ever relative to the overall market, a sign investors are less concerned about future losses. Short sellers have withdrawn bearish bets on the ETF to near the lowest level in 14 months, data compiled by Markit Securities Ltd. and Bloomberg show.

Energy producers, the worst stocks in the S&P 500 over the past three years, are back in favor as oil rose above $100 a barrel and investors bought companies with with stable earnings. Valuations have risen since early March, when the industry was the second-cheapest group in the S&P 500, amid signs of economic improvement in the U.S. and China, the two biggest energy consumers.

“Energy was universally despised and loathed by investors in spite of the fact that valuations were very compelling,” Ted Harper, who helps manage more than $10 billion for Frost Investment Advisors LLC in Houston, said by phone on May 22. “Consistent performance by the companies will eventually erode some of the skepticism. Energy continues to look attractive.”

Implied Volatility

The advance in energy stocks this quarter is more than double the 2.1 percent return for the S&P 500. The outperformance marks a turnaround from the prior three years, when the energy gauge ranked last, with an 11 percent advance. The broader equity index rallied 41 percent in that period.

Implied volatility, a gauge of options prices, for the energy ETF is 13.3, compared with 11.6 for the SPDR S&P 500 ETF Trust, according to data on three-month contracts compiled by Bloomberg. The spread reached 0.38 point on May 6, the smallest gap on record.

Short interest on the energy ETF has fallen to 8.3 percent of shares outstanding, down from a 2014 high of 14 percent reached two months ago, data compiled by Markit and Bloomberg show.

Any weakness in the global economy will curb demand for energy, according to Michael Binger, who helps oversee $550 million as a senior portfolio manager at Gradient Investments LLC in Arden Hills, Minnesota. West Texas Intermediate crude declined from a five-week high yesterday on speculation that U.S. inventories are sufficient to meet increasing fuel demand.

Energy Demand

“Most energy companies make money two ways, you increase production and the price goes up,” Binger said in a phone interview last week. “A slowdown will be a risk to energy prices and energy demand.”

The Chicago Board Options Exchange Crude Oil Volatility Index, a measure of expectations for swings in oil prices, has fallen 9.4 percent this year to 16.10. WTI for July delivery retreated 0.2 percent to $104.11 a barrel yesterday. It’s up 5.6 percent this year.

A gauge of manufacturing in China rose to a five-month high last week and recent U.S. data from a factory-output index to durable-goods orders have topped estimates. The Energy Select Sector SPDR Fund, known by its ticker XLE, climbed 0.3 percent yesterday and is up 6 percent this quarter.

Less Bearish

Energy shares have benefited as investors shifted money out of Internet stocks or companies previously seen as having greater growth potential, said John Goltermann, who helps oversee more than $900 million at Obermeyer Asset Management Inc. in Aspen, Colorado.

The S&P 500 Energy Index, tracking 44 companies from Exxon Mobil Corp. to Schlumberger Ltd., is trading at 15.9 times reported earnings, compared with the multiple of 17.6 in the broad equity gauge. At the beginning of March, the multiple for oil stocks was 14.6, data compiled by Bloomberg show.

“This is a manifestation of a more bullish or at least less bearish view on energy,” Goltermann said in a phone interview last week. “After a couple years of neutral or maybe slightly bearish views on energy, that’s reversing itself. Positioning around that is smart.”

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