VDE: Oil’s Bounce Warrants A Energy-Sector Refresh (Rating Upgrade) (NYSEARCA:VDE)

WTI crude oil continues to meet buyers in the low $60s per barrel. Last week, heavy selling through Tuesday resulted in the prompt-month contract dipping below $66, right down to critical support levels. As we’ve seen several times since late 2021, a rally took place in short order. Oil ended the week near $69 after briefly trading north of $70.

All that drama in the commodity comes as the Energy sector has posted very poor relative strength compared to the broader market. The oil and gas space notched its worst level versus the S&P 500 of the year last week, but I see opportunity in this high yield, big free cash flow slice of the US equity market.

I am upgrading shares of the Vanguard Energy Index Fund (NYSEARCA:VDE). I was neutral on the ETF back in the first quarter, and shares are up just 4.3% total return in the past seven months, sharply losing ground to the SPX which is up about 12% in that span. Lower oil prices is certainly a culprit, but so too are fears of ongoing weakness in China and broader supply/demand softness in both WTI and Brent oil.

WTI Crude Oil Hits Critical Support

Energy Sector Relative Strength Sinks to a New Low

Energy Sector Sports the Highest Total Shareholder Yield

According to the issuer, VDE seeks to track the performance of a benchmark index that measures the investment return of stocks in the Energy sector. It holds stocks of companies involved in the exploration and production of energy products such as oil, natural gas, and coal. The fund employs a passively managed approach, using a full-replication strategy when possible and a sampling strategy if regulatory constraints dictate.

VDE is a large ETF, now with total assets under management of $10.1 billion, up from $9.5 billion in February. The fund is an ideal candidate for investors seeking to be long oil and gas equities over the long haul given its low 0.10% annual expense ratio. Income investors are also drawn to VDE due to its 3.2% forward dividend yield – about 180 basis points above that of the S&P 500.

Share-price momentum has been nothing short of dreadful in the last several months, however. That counters relatively strong price action through much of the first quarter of 2024. VDE is also a risky product due to its elevated standard deviation trends and a somewhat concentrated allocation. But liquidity is solid with this low-cost sector ETF – its average daily volume is more than 350,000 shares and the 30-day median bid/ask spread is tight at just two basis points, per Vanguard.

Looking closer at the portfolio, the 4-star, Gold-rated ETF by Morningstar plots on the far left part of the style box, indicating its bent to value. There’s also a material 44% weighting in domestic SMID cap stocks, adding to its cyclical exposure. I like that the valuation is just 13.7x right now, though long-term EPS growth is not particularly high at 8.1%. Still, the resulting PEG ratio is decent at 1.7.

Key risks include lower oil prices, bearish sentiment around global growth, specifically in China, and very high US energy production.

VDE: Portfolio & Factor Profiles

S&P 500 Sector Summary

What troubles some investors is that VDE and its counterpart the Energy Select Sector SPDR ETF (XLE) are highly allocated to two large integrated oil companies – Exxon Mobil (XOM) and Chevron (CVX).

I assert, though, that those behemoths are inexpensive stocks (I have a buy rating on both) and produce hefty amounts of free cash flow, even with WTI now sub-$70.

VDE: Holdings & Dividend Information

Another risk right now is the historical seasonal trend. September is among the worst months for VDE, but gains have been had, on average, in October and November over the past 10 years.

So, once we get through the next two weeks or so, seasonal headwinds flip to tailwinds.

VDE: Weak September Seasonality, Bullish Oct-Nov Trends

The Technical Take

With a solid valuation and the potential for a bounce in oil prices, VDE’s technical situation also shows apparent support being in play. Notice in the chart below that the ETF attracted bids at an uptrend support line near $115 last week. It’s not all rosy, though, as there’s also a downtrending resistance line that enters the scene at $125. Considering that the long-term 200-day moving average is now flat in its slope after having trended higher for most of the last four years, the bears are trying to assert themselves ahead of the end of 2024.

Also take a look at the RSI momentum oscillator at the top of the graph – it has been ranging in a bearish zone between 30 and 60, never reaching the 70 spot like it did during VDE’s price rise from 2021 through this past April. In terms of downside support, below $115 we find the YTD low near $110 with further buying potential in the $104 to $105 zone. Finally, there is a high amount of volume by price up to $130, so the bulls have their work cut out for them if they want to sustain a rally.

Overall, VDE’s relative strength is very poor, but its chart shows the potential for a recovery off trendline support.

VDE: Shares Reach Trendline Support, Weak RSI Momentum

The Bottom Line

I have a buy rating on VDE. I see its valuation as attractive today while the significant pullback from its all-time high earlier this year has hit important support in my view.