"It Was the Worst of Times" This bullishness stands in stark contrast to the performance of traditional energy stocks. Energy has been by far the worst-performing stock market sector in the U.S. this year. Near the market bottom, the combined market cap of companies in the S&P 500 energy sector index almost halved since the start of 2020. Demand for oil remains far below where it was a year ago. In April, the price of oil even briefly fell below zero. The incoming Biden administration's policies on climate change - electrification, limits on methane emissions and opposition to fracking - are also negative for traditional energy companies. It's no wonder that, with more than 45% of its holdings in just Exxon (NYSE: XOM) and Chevron (NYSE: CVX), the Energy Select Sector SPDR Fund (NYSE: XLE) is down 39.24% in 2020. Making Money From Energy Stocks The chart below compares the performance of the Energy Select Sector Fund with that of the First Trust Clean Edge Fund in 2020. And for most investors, this chart is all they need to do the obvious: Invest in the First Trust Clean Edge Fund and avoid the Energy Select Sector Fund. Alas, my contrarian instincts tell me to look in the opposite direction. "Buy Value..." Traditional energy stocks are as cheap as they have ever been. SentimenTrader recently pointed out that 470 out of 663 U.S.-listed stocks in the energy sector have a share price under $5. That's more than 70% of stocks in the sector! More than 390 stocks are trading below $2. In the past 20-plus years, no other energy bust has seen more than 65% of these firms with a share price under $5. There were only four other times when more than 55% of energy companies were trading below $5. The Energy Select Sector Fund was up an average of 47% 12 months later. And it was up by 82% and 99.7% within the next 24 and 36 months, respectively. "Sell Hysteria" "They never ring a bell at the top of a market" is an old Wall Street adage. But the announcement of Tesla's entering the S&P 500 Index at the end of December might be close enough. By any conventional measures, Tesla is not an automobile stock. Nor is it a tech company. No, Tesla is a religion. After all, Tesla trades at a price-to-earnings (P/E) ratio of 930! And the First Trust Clean Edge Fund trades at a P/E of 316! Meanwhile, the Energy Select Sector Fund has a P/E of negative 5.29! Such disparities in valuation are unprecedented in my investment career. Based on my reading of financial history, I expect the plot to unfold as follows... Investors will embrace clean energy as the future with clarion calls of "This time it's different!" (Remember the "China Miracle," 3D printing and, most recently, cannabis stocks?) Investors will bid up shares in the chosen sector to absurd levels. Analysts will justify these off-the-chart valuations with newfangled metrics. Inevitably, the stocks will come crashing back to earth. And savvy investors will make money on the way up and on the way down. The bottom line? As famed investor Jim Rogers advises, "Buy value... and sell hysteria." That's precisely how I intend to play both clean and traditional energy stocks. Good investing, Nicholas |
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