By Lewis Krauskopf

NEW YORK, (Reuters) – Investors are faced with a difficult decision after a scorching rally of U.S. Energy Shares. They must decide whether to hold onto their gains despite increasing concerns that global growth might slow down or to lock in profits in the one area of stock market that is thriving this year.

The energy sector has surged 55.7% year-to-date on the back of soaring oil prices, making it a welcome counterweight in portfolios during a year in which the broader S&P 500 has declined by 13.3%.

Over the past decade, certain energy names have provided higher returns than high-flying tech over the years. Exxon Mobil Corp (NYSE 🙂 Chevron Corp (NYSE 🙂 and 49% respectively have seen gains of 57%, 49%, and 49%, respectively. Occidental Petroleum Corp has seen a jump of around 140%. Oil prices rose 53% in the past year, which has supported oil and gas stocks while they have helped to spur the highest inflation rates for decades.

Energy shares have survived hawkish pivots by the Federal Reserve and other central bank central banks so far. This has fueled concerns about slower growth, which could impact energy demand. However, some investors could be profiting: although the sector’s share price is up 11% from late April, Refinitiv Lipper data shows that there has been five weeks straight of net outflows overall for funds in the energy sector.

James Ragan from D.A. Wealth Management Research, said that the fundamentals of the group have improved significantly this year. Davidson. “There are risks that we could experience some destruction of demand if there is a deeper global recession.”

Investors sticking with their energy bets cite the sector’s strong earnings prospects, valuations that remain low on a historical basis and expectations oil prices will stay elevated following the conflict in Ukraine that tightened supply.

S&P 500 energy company earnings overall topped expectations in the first quarter and are expected to more than double in 2022, versus a 9% rise for the broad S&P 500, according to Refinitiv.

According to Refinitiv Datastream, companies in 21-stock sector energy trade at 10x forward earnings estimates, as compared to a long-term median 15.5 times. The S&P 500 trades at about 17 times, by comparison.

Energy stocks “don’t have a secular growth story like Tech, so investors only pay attention to these names when they are dramatically outperforming on the bottom line and estimates are going up,” wrote Nicholas Colas, co-founder of DataTrek Research, in a recent note. “That is happening now and given how low 2023 estimates are we expect that will continue.”

Graphic: Energy sector vs US stock market https://fingfx.thomsonreuters.com/gfx/mkt/xmpjoxybyvr/Pasted%20image%201654022113936.png

Some investors think that more disciplined capital expenditure from corporations is helping to support the sector.

According to Baker Hughes’ latest count, there are 727 oil rigs in operation in America, as compared to more than 1,800 at mid-2014, when crude prices in the United States surpassed $100 per barrel.

Walter Todd, chief investor officer of Greenwood Capital (NYSE:), said that in previous cycles, companies would have spent like drunken sailors to build new rigs and search for oil. The cash flow profile of these companies now is unlike anything we’ve seen in the space for a very long time.

Others, however, are concerned demand may wane as China’s economy is hit by coronavirus-related lockdowns or if the U.S. economy slides into a recession – a possibility as the Fed pledges to tighten monetary policy until it tames inflation.

CFRA reduced its recommended exposure for the energy sector from “overweight” to “marketweight”, stating that because of “the rising risk of recession and stagflation CFRA believes global demand will struggle to remain strong.”

Shares could also suffer if investors rotate back in to technology or other areas of the market punished in this year’s selloff. The energy sector is up some 40% over the past decade versus a roughly 450% gain for the S&P 500 technology sector.

A large part of the underperformance is due to investors shunning oil companies, fossil fuel, and environmental concerns.

Investors are still recognizing the fact that there may not be many alternative energy sources in the near future, stated Hans Olsen chief investment officer of Fiduciary Trust Company. He has a positive outlook about this sector.

“You have both a valuation argument and … the operating environment we are in right now is really quite positive for the energy companies,” Olsen said.

Graphic: Energy sector in US stock market https://fingfx.thomsonreuters.com/gfx/mkt/mypmnwybwvr/Pasted%20image%201654022339285.png