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More Gains in the Pipeline

In about three weeks, I will review my energy predictions for 2016. Despite my glaring miss on the presidential election, most of the predictions I made back in January look like they will prove to be correct.

One of these was my prediction that the Energy Select Sector SPDR ETF (NYSE: XLE) would rise at least 15% in 2016. The XLE actually reached that level by mid-year, and as I write this it is up nearly 30% for the year. The XLE represents the largest energy companies in the S&P 500. The five largest holdings in order are ExxonMobil (NYSE: XOM) with a 16.8% weighting, Chevron (NYSE: CVX) at 14.7%, Schlumberger (NYSE: SLB) at 8.1%, Pioneer Natural Resources (NYSE: PXD) at 4.8% and EOG Resources (NYSE: EOG) at 4.7%.  

Because the XLE groups the stocks of large energy companies from different sub-sectors (e.g., integrated, oil production, equipment services), it is a good benchmark for conservative energy investors. The S&P Oil & Gas Exploration & Production SPDR ETF (NYSE: XOP) is more representative of the smaller-cap drillers. As such it’s more aggressive and volatile than the XLE, and is up more than 40% year-to-date.

Many people have asked whether it’s too late to jump into energy stocks given the recent rally. My answer to that is that while those on the sidelines have missed this year-end rally, the next four years are likely to be good to energy investors. Bargain hunters or short-term speculators may wish to wait for some weakness, though we are unlikely to see a repeat of the year-end tax selling as in the two prior years. But if your time horizon is more than about three years I don’t think you can go wrong jumping in now.

However, there is one niche where bargains still beckon. While I have seen one undervalued segment of the energy sector after another rally this year, the midstream processors, many of them organized as master limited partnerships (MLPs), haven’t done much since the initial springtime rebound. There have certainly been many winners in the sector, as our model portfolios at The Energy Strategist and MLP Profits demonstrate. However, many energy pipeline operators  have lagged, as evidenced by the performance of the Alerian MLP Index (AMZ), which captures about 75% of the midstream sector’s market capitalization.

Although the AMZ has rallied strongly since the lows of February, its 4% YTD return lags well behind the XLE and XOP:

20161215TELamz

This is partially a function of increasingly negative media coverage of pipelines, cash flows taxed by the energy bear market and concerns about rising interest rates. However, I believe the downside risk at this point is low and given the likely mix of energy policies from the Trump Administration the midstream sector should benefit.

When I make my predictions in early January, expect one to focus on the performance of the AMZ in 2017. But you needn’t wait until then for actionable advice on energy investments. The Energy Strategist and MLP Profits cover the entire spectrum from speculative producer picks to the megacap processors.  

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

 


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