Rising Oil Prices Bode Well for Energy ETFs

Standard & Poor’s is expecting oil to hit $95.15 a barrel next year

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With the U.S. economy apparently shifting into growth mode, according to S&P Economics, U.S. gross domestic product (GDP) growth is expected to be 3% this year.

One indicator of accelerating economic growth, of course, is the rising price of oil.

In December, benchmark U.S. crude oil prices climbed past the $90 a barrel mark for the first time since early 2008, he says, amid slumping domestic crude oil inventories and optimism that demand will rise as economic activity picks up.

Rising oil prices have helped energy stocks outperform the broader market in recent months. Recently, oil was trading at about $91 a barrel, and S&P anticipates oil reaching $95.15 a barrel by the end of 2012.

S&P Equity Strategy recommends a market weighting to the S&P 500 energy sector.

In 2010, the sector gained 18.9%, with much of the gain, 19.8%, in the last 13 weeks of the year.

S&P says its equity analysts have a positive fundamental outlook on the integrated oil & gas industry, which makes up more than half of the market cap of the sector.

Gasoline makes up 3% of the average U.S. household budget, according to David Wyss, S&P chief economist. Overall energy costs comprise 6% of the average household budget, including gasoline, electricity, and natural gas.

The energy sector's recent valuation of 13.1 times estimated 2011 earnings per share (EPS) is below the 500's P/E of 13.6, as the unpredictability of oil prices leads investors to generally assign this sector a lower valuation than the broader market. The sector's P/E-to-projected-five-year EPS growth rate (PEG) ratio of 0.9 is below the broader market's 1.

ETF investors have a wide variety of choices when it comes to the energy sector. There are two dozen energy ETFs offering access to strategies that target both domestic and international equities. Most of these funds focus on large oil and gas companies, though some own small-cap, natural gas, or coal companies.

Four of these funds -- State Street's SPDR Energy Select Sector ETF, iShares S&P Global Energy Sector Index ETF, iShares Dow Jones US Energy Sector Index ETF, and Vanguard Energy Index ETF - have an "overweight" recommendation from Standard & Poor's, which assess ETFs using 10 different metrics measuring performance, risk, and cost.

The ETFs are substantially similar in terms of their underlying holdings.

The State Street ETF is the largest and least expensive to own, followed by Vanguard, while the iShares S&P Global ETF has the largest dividend yield. Performance among the group has been highly similar as well, though the iShares S&P Global ETF has underperformed the others over the past year.

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