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The market's worst-performing sector is due for some upside, two traders say. Here's how they'd play it

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What two traders make of the market's worst-performing sector

There could be upside in store for the market's worst-performing sector.

S&P 500 energy stocks have underperformed the index's 10 other sectors over a range of time frames including in Tuesday's trading session, this week, this month, this year and over the last 12 months.

The group has encountered numerous headwinds in 2020, not least of which was the sharp decrease in economic activity brought about by the coronavirus pandemic. Increased efforts to transition to renewable energy sources such as hydrogen have also pressured traditional energy stocks.

Oil prices have declined nearly 32% year to date, while the Energy Select Sector SPDR Fund (XLE), which tracks energy stocks, has lost nearly 50%.

But the tide might be turning for the group, according to two traders.

"Hydrocarbons will be here for quite a while and there'll be a big transition period" to sources such as battery power, Boris Schlossberg, managing director of FX strategy at BK Asset Management, told CNBC's "Trading Nation" on Tuesday.

"For that reason alone, I think the energy sector at this point actually presents a pretty decent value, especially because right now from a financial point of view, there's a sort of a game of chicken going on as far as dividends go."

Industry stalwarts Exxon Mobil and Chevron are still yielding 10% and 7% in dividends, respectively, and neither company has announced plans to cut them, Schlossberg said.

"If they do not, that makes them one of the greatest yield plays in the world right now at a time when the 10-year is trading 65 basis points," he said. "Now, if they do cut their dividends — let's say they even cut it by half — that still makes it a very attractive yield and at the same time also lowers their cash flow needs and therefore I think is a chance for the stock value to go up."

As such, investors with longer-term time horizons might want to consider the group at these levels, particularly considering the resilience of energy demand and the possibilities for merger activity if key stocks stay low, Schlossberg said.

"If you're a long-term holder, this is one of those great opportunities where you have a chance to buy a very, very beaten-down sector relatively cheaply for the intermediate term, even though very, very long term, certainly, the prospects for the whole sector are kind of negative," he said.

Bill Baruch, president and founder of Blue Line Capital and Blue Line Futures, agreed with Schlossberg's assessment.

"This weakness that we've seen here this year I think presents a longer-term value opportunity," he said in the same "Trading Nation" interview.

Crude oil, which was at roughly $39 a barrel after Tuesday's market close, has "tremendous value" at the $34-35 level, Baruch said.

"If it gets down there, it's going to continue to pressure the stocks," he said. "I think there's great value in the stocks. I think Chevron is really a great one."

Baruch said he began allocating assets to energy last week with Chevron as a "centerpiece" to the strategy, adding that the $70 a share level in Chevron "is a good point of balance for the stock."

Chevron closed down nearly 3% at $71.90 on Tuesday.

"And, as Boris mentioned, those dividends [are] really great right now. Even if they do end up cutting those dividends, you could see a flush. I think that flush would be a buying opportunity," Baruch said. "So, I've begun to allocate in the space and I think there's good value there over the long run."

The XLE closed almost 3% lower on Tuesday.

Disclosures: Baruch owns shares of Chevron.

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