Are Energy Stocks Undervalued?

| About: Energy Select (XLE)

Summary

The performance of energy stocks relative to the S&P 500 is well correlated with the price of oil.

Today’s investors have done a reasonable job of discounting the pair.

The energy sector seems fairly priced, unless one is making a directional bet on the price of oil.

Energy stocks have tumbled along with crude oil. But have they reached the bargain basement? This depends on one's outlook for the price of crude. The performance of energy stocks relative to the broad market is well correlated with the underlying commodity.

The charts below illustrate the historic relationship since 1984, a period with many ups and downs. Chart 1 presents the data in chronological order. Unsurprisingly, the link is strong but not precise.

Chart 2 presents a scatter plot, connecting oil prices with relative-strength of the energy sector. We note that today's investors have done a reasonable job of discounting the pair. The energy sector seems fairly priced, unless one is making a directional bet on the price of oil.

This is not to say that specific bargains cannot be found. Market turmoil during tax-selling season is undoubtedly presenting specific opportunities. The entire sector, however, is not dramatically undervalued relative to the price of oil.

Chart 1

Chart 2

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

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