Huge ‘Value Trap’ if you invest in Energy Stocks

The stock market’s wild trading recently has raised the specter of a bear market emerging from hibernation. That means it’s time for investors conditioned to buy all declines to be mindful of the “value trap” — a declining stock, sector, or index that appears cheap after a selloff but keeps declining.

Or in Wall Street parlance, when investors try to “catch a falling knife.”

This year’s biggest value trap is the energy sector — especially companies involved with oil production. From June 2014 through August 17, oil dropped from its peak of slightly more than $100 per barrel, to the low-$40 range, before rebounding into the mid-$40s as of August 28.

The oil price drop has caused energy stocks to suffer as well, making energy the worst-performing sector in the S&P 500 SPX, +0.06%   so far this year. The energy sector now comprises around 7% of the S&P 500.

Because of oil’s price decline, both the stocks of the largest exploration and production companies and the largest oilfield service companies have declined precipitously since June 2014.

Still, a number hedge funds and mutual funds waded into the energy sector. A recent report from Reuters indicated that some top value-hunting hedge funds remained bullish on energy stocks in the second quarter of 2015 even as the oil price slump intensified. The A-list funds include Baupost, Greenlight, Jana Partners, Third Point, Magnetar, and hayman Capital.

Some hedge funds are mixed on the sector. David Einhorn’s Greenlight Capital is long Consol Energy CNZ, +3.82%, but Einhorn gave a scathing presentation at the Ira Sohn Conference on many frackers including Pioneer Energy Services PES, +4.70%, which he accused of burning through cash. Another notable investor, Jim Chanos of Kynikos Associates, is short largest producers, including Chevron CVX, +3.59%