The proverbial knife is falling.
After nearly a 30 percent drop in energy shares since the summer, traders jumped in on Tuesday to try to call the bottom in oil and gas stocks, which have been hammered by the decline in commodities prices and worries about global demand.
The S&P 500 energy sector hit its lowest level in almost two years on Tuesday but staged a comeback that at one point gave it its best day since 2011. While the broad stock market could not hold onto significant gains Tuesday, energy stocks still managed to finish positive, gaining 0.7 percent.
The volatility suggests there are investors that believe the sector now represents substantial value after the declines, and therefore has a high potential for gains in coming months.
“With the stocks down so big, (it) seems to be an intermediate opportunity in the group,” said Doug Kass, president of Seabreeze Partners in Palm Beach, Florida.
“I’m trying to stick with Exxon, Chevron, Devon, the ones with rock-solid balance sheets. I’m not buying stocks down 16 to 17 percent, the secondary and tertiary companies.”
Between the beginning of the year and June 23, the sector had gained 13 percent on the back of a steady rise in oil prices and expectations for improved growth.
Since then, energy has been a disaster. The index currently ranks as the market’s most distant laggard among the S&P’s 10 sectors, according to a Relative Rotation Graph study, which analyzes the relative performance of the constituents of an index.
Booming oil production in North America and OPEC refusing to cut output have sent both U.S. crude and international oil prices to five-year lows, dragging energy companies down with the falling commodity markets.
Some stocks in the energy sector are now quite inexpensive compared with the S&P 500 universe. ConocoPhillips, Chevron Corp and Exxon Mobil Corp all have forward price-to-earnings estimates between 10.2 and 11.4, according to Thomson Reuters StarMine data. The forward P/E on the S&P 500 is 16.1, meaning investors pay 32 percent less for a dollar in earnings in those energy names than on the overall index.
“We’ve definitely hit a value area in the energy sector,” said John Kosar, director of research at Asbury Research in Chicago.
“What is missing is that initial flow of assets back into the sector, which basically makes the bottom happen and starts the new trend.”
That may be starting to happen, however modestly. The SPDRs S&P Energy Sector ETF saw more than 57 million shares change hands on Tuesday, the busiest day for the ETF since mid-October.
Some options action also showed investors starting to bet on oil recovering next year. A trade in the United States Oil Fund , the most-traded oil ETF, appeared to bet on the ETF recovering some of its recent losses.
In addition, the number of Exxon calls – a bet on a stock increasing – outnumbered puts by a ratio of 1.6 to 1 on Tuesday. That is the highest it has been since Dec. 5, according to Trade Alert.
Some of the beaten-down smaller companies in the sector were the best performers on Tuesday. Denbury Resources Inc, down 58.6 percent this year, jumped 7.3 percent Tuesday. Range Resources Corp, down 30.9 percent year-to-date, jumped 5.1 percent. Both companies have seen substantial increases in shares on loan for short bets in recent weeks, according to Markit, which tracks short-interest data.