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A blazing U.S. stock market rally left shares of energy companies behind in the first six months of 2023 as faltering global growth sapped expectations of oil demand. Some contrarian investors are betting a second half rebound may be in the works.

While the U.S. economy has been more resilient than expected, weaker growth in the eurozone and China has weighed on oil prices, pushing Brent crude down about 16 per cent for the year. That has hurt shares of energy companies: after soaring in 2022, the S&P 500 energy sector has lost nearly 10 per cent this year, making it the index’s worst performing sector. The benchmark S&P 500, by comparison, is up 14 per cent.

Most investors believe central bank interest rate hikes to fight inflation should keep a lid on global growth for the time being. Yet some are positioning for a rebound in energy shares, drawn by attractive valuations and signs the U.S. will continue to stave off an economic downturn.

“We don’t have a recession as our base-case scenario in the U.S., so we think there is scope for the laggards to catch up,” said David Lefkowitz, senior equity strategist at UBS Wealth Management. “Energy is at the top of that list.”

This month, UBS upgraded energy to “most preferred,” citing dwindling supply and signs that a U.S. recession, if it comes at all, may be less severe than expected. Areas of the U.S. economy such as employment and consumer spending have remained resilient even as the Federal Reserve has tightened monetary policy.

Analysts at TD Securities said oil production cuts from Saudi Arabia and supply reductions from OPEC+ “are likely to more than offset the surplus accumulated in the first half of 2023,” lifting the price of U.S. West Texas Intermediate (WTI) to $90 per barrel. That would be sharply higher than Tuesday’s settlement price of $67.70 for WTI, with global benchmark Brent settling at $72.26.

Oil markets have shown signs of growing tighter. U.S. drillers cut the number of operating rigs last week for the eighth week in a row, putting total rigs in service down 9 per cent over the course of the year to the lowest since April, 2022, according to Baker Hughes.

Stan Majcher, a portfolio manager at Hotchkis & Wiley, is among those counting on oil prices rebounding due to tight supply. He also believes shares of many companies in the sector are cheap on a historical basis and is increasing his overall exposure to energy stocks, including Kosmos Energy Ltd.

The S&P 500 energy sector is trading at a forward price to earnings ratio of 10.4 times, compared with about 19 times for the S&P 500, according to Refinitiv Datastream. The sector has traded at a historical median forward P/E of 15.3 times.

Betting on a rebound in energy stocks remains very much a contrarian play in a market whose march higher has been led by a handful of giant tech and growth stocks.

The proportion of investors overweight in technology stocks relative to energy stocks is at its highest since September, 2021, a Bank of America Survey showed, and fund manager allocations to energy shares are at their lowest level since December 2020.

Euro zone business growth stalled this month as a manufacturing recession deepened and a previously resilient services sector barely grew, suggesting the region’s economy remained shaky.

“Oil is a global commodity, so we don’t see this turning around until growth is a global story and not just a U.S. story,” said Charles Lemonides, head of hedge fund ValueWorks LLC.

He has been reducing exposure to energy stocks and increasing his short positions in companies such as Hess Corp. and Occidental Petroleum Corp., which he believes are trading at rich valuations.

Yet others are betting on stronger growth than expected, especially in the U.S.

Sam Peters, portfolio manager at ClearBridge Investments, recently moved energy to the largest overweight in his portfolio. “At least a shallow recession” would be needed to justify the current level of oil prices, he said.

“If you don’t get it, the path of least resistance is for oil prices to move much higher,” he said.

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