Energy stocks have been largely sitting out the recent broader market rally, despite a stellar 2022 performance.

Expectations of easing inflation and a slowdown of Federal Reserve rate hikes have kept the optimism alive that a ‘soft landing’ for the economy is possible, sending growth stocks higher—and leaving cyclicals behind since the start of the year.

The S&P 500’s Energy Select Sector (XLE) is up 1% compared to the benchmark index’s gain of more than 7%—and the Nasdaq’s 14% rise over the same period.

The market action for 2023 has thus far been a reversal of what happened last year when technology, consumer discretionary and communication services stocks got decimated—and oil and gas stocks soared. XLE ended 2022 up 57% compared to the S&P’s (^GSPC) 19% decline.

One example of energy sector stock woes: on Wednesday, Devon Energy’s (DVN) stock dragged down its peers after the shale producer warned of increased costs. The company’s capital spending is expected to produce about 1.5% less oil than what Wall Street had anticipated.

To be sure, energy stocks started the year at a very high level. Shares of ExxonMobil (XOM), for example, which saw record profits last year, hit a 52-week high in early February. Still, the oil and gas giant was recently downgraded to Hold from Buy at CFRA research given its run-up over the last year.

“Our change in opinion is based on valuation. Shares are up 42% in the last 12 months,” analyst Stewart Glickman said in a note to investors, “In the near term, we think refining margins could narrow as price caps on Russian refined products work their way into the system in February, and we think oil services cost pressures may intensify.”

The energy sector’s performance is often tied to its underlying commodity price, which in this case has been stagnant lately. Brent crude (BZ=F) has traded as low as $77 this year, but mostly within a range of $82-85 as an EU ban on Russian oil products went into effect February 5th.

West Texas Intermediate (CL=F) crude prices were hovering above $81 per barrel on January 23rd, and in recent weeks have been under pressure because of building inventories. On Thursday, WTI was trading at $78.41 per barrel.

The good news? It’s expected oil prices will rise from here, as seasonal demand increases in the Spring, giving a boost to energy stocks.

The impact of China’s full reopening post Covid lockdowns is also expected to fuel oil demand.

A staff member refuels a car at a gas station in Haizhou District of Lianyungang, east China's Jiangsu Province, Jan. 17, 2023.  China will cut the retail prices of gasoline and diesel from Wednesday, based on the recent changes in international oil prices, the country's top economic planner said Tuesday.   Gasoline and diesel prices will dip by 205 yuan about 30 U.S. dollars per tonne and 195 yuan per tonne, respectively, said the National Development and Reform Commission. (Photo by Geng Yuhe/Xinhua via Getty Images)

A staff member refuels a car at a gas station in Haizhou District of Lianyungang, east China’s Jiangsu Province, Jan. 17, 2023. (Photo by Geng Yuhe/Xinhua via Getty Images)

China is the main thesis for bullish views on crude oil prices, though the economy’s reopening is not linear and its impact on the oil market may not be as fast as analyst had expected, according to Rebecca Babin, senior energy trader at CIBC Private Wealth.

“That doesn’t mean it’s not coming [price impact on oil], and I think that it is. But the magnitude and the timing of it is what keeps the market on its toes and trading with a lot of volatility,” Babin recently told Yahoo Finance Live.

For now, energy bulls still lean towards cyclical equities over high tech growth names, even if that isn’t part of the recent 2023 trend.

“I overwhelmingly prefer energy stocks over technology stocks,” Louis Navellier of Navellier Calculated Investing recently told Yahoo Finance, “Energy has much stronger forecasted revenue and earnings, plus continues to trade well below the PE ratio for the S&P 500.”

Ines is a senior business reporter for Yahoo Finance. Follow her on Twitter at @ines_ferre

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