Is energy sector undervalued despite its massive rally?

The S&P 500 Energy ETF (XLE) is up 53% year-to-date, outperforming the other ten sectors by a wide margin.

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However, energy equities have been dropping recently due to a decline in crude oil prices. On Tuesday, Brent futures stayed around $80 per barrel, while WTI futures dipped below $75.

One side is bullish

Even after this year’s crazy run, a strategist believes energy stocks have a chance to rise.

“They’re still cheap if you look at it on most metrics,” Tortoise portfolio manager Rob Thummel told Yahoo Finance Live this week.

“The market is really rewarding companies that have positive earnings and free cash flow. That’s what this sector has,” said Thummel,” I still think there’s room for it to continue, even if oil prices stay the same or even if they fall a little bit.”

Currently, it appears that China is influencing oil prices. What we’ve seen is undeniably the anxiety that the China reopening will be delayed. When Chinese economic growth resumes, oil prices will most likely increase.

Thummel additionally noted that global crude stockpiles are small, saying that in the future, the demand for oil will continue to rise. Still, there will not be a significant increase in supply.

Another side is bearish

On the other hand, David Solomon, the chief executive officer of Goldman Sachs (GS), anticipates that the stock market’s decline will continue in 2023 and that the likelihood of a US economic recession is more than 50%.

Solomon stated on Tuesday at the Wall Street Journal’s CEO Council Summit that he expects equities, oil, and real estate (both commercial and residential) to decline next year. At the same time, the US currency would climb somewhat.

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Solomon assessed the possibility of a “soft landing,” or a slowing in inflation that does not trigger a recession, at only 35% for the US economy.

“I would define a soft landing as we get inflation back close to 4% inflation, maybe we have a 5% terminal rate, and we have 1% growth,” Solomon said. “I think there’s a reasonable possibility we could navigate a scenario like that.”

Another correction in the bull market

Technically speaking, it looks like this year’s highs (reached in June) were just too much for the bulls, and quick profit-taking near $92 brought the XLE index sharply lower. It looks like the next target in this correction could be the 200-day moving average near $80 (the blue line). Nevertheless, the medium-term uptrend should remain intact as oil seems oversold and could be ready for a meaningful bounce.

XLE index daily chart, Source: Author´s analysis, tradingview.com