Energy stocks crushed the S&P 500 in 2022, and Wall Street loves the sector next year

Energy stocks have been this year's biggest winners in a bleak year for equities.

And Wall Street is betting the sector’s outperformance will persist in the new year.

Even as the price of oil pulls back from this year's highs, energy stocks look poised to charge higher thanks to relatively cheap valuations and earnings expectations that appear to be a bright spot in an otherwise grim outlook for S&P 500 earnings estimates.

“The bottom line here is that when you think about the earnings of the S&P 500 as a whole, even with muted expectations for earnings next year, energy is going to represent 9% of the index's earnings and it's only 5% of the weighting in the S&P 500,” Evercore ISI Senior Managing Director Julian Emanuel told Yahoo Finance Live in an interview.

“And when you look at the valuations in the energy sector broadly, they are already discounting the recession multiple wise, that the rest of the S&P 500 has yet to fully discount.”

Analysts have been trimming their earnings per share forecasts for 2023 all year, with downward revisions seen for 9 of 11 sectors in the S&P 500 between September 30 and November 30, according to FactSet data.

However, two sectors saw an increase in their bottom-up EPS estimate over that period, led by a 4.4% revision in expectations for the energy sector. Estimates for utilities stocks also rose 0.9% over that period.

Two sectors witnessed an increase in their bottom-up EPS estimate for CY 2023 between Sept. 30 and Nov. 30, led by the Energy (+4.4%) sector. (Source: FactSet) (FactSet)

The upward changes to estimates for energy come even as the sector is poised to face difficult year-over-year comparisons in 2023, with an expected revenue decline of -7.3% next year after a blowout 2022, per FactSet data.

Energy has also been the largest contributor to earnings growth for the S&P 500 this year. Excluding energy's 5.1% earnings growth, the index would be set to report an earnings decline of -1.8%.

Strategists also point out that oil companies have been prudent despite this year's surge in oil prices and optimism about persistently higher prices.

CIBC Private Wealth U.S. Sr. Energy Trader Rebecca Babin told Yahoo Finance Live that companies “are not making rash decisions about increasing production” based on swings in oil prices.

“They are less levered,” Babin said. “They are more disciplined, and they are super focused on returning to cash.”

Not only has energy surged nearly 55% year-to-date in 2022, but it has no competition — the other 10 sectors in the S&P 500 are negative this year, while the broader benchmark index is down roughly 19% this year.

Shares of Exxon Mobil (XOM), the largest oil and gas company in the U.S., are up about 65% this year. Chevron (CVX), the second-largest, is up more than 40% in 2022.

Meanwhile, Occidental Petroleum (OXY), a star performer this year, with shares more than doubling as Warren Buffett's Berkshire Hathaway increased its stake in the company throughout the year, now holding a 20.9% position in the company.

Oil prices, meanwhile, have reversed all of their gains this year after touching a high north of $120 per barrel in June. Supply-and-demand concerns related to rising interest rates, inflation, COVID lockdowns in China, and Russia's war in Ukraine have all contributed to extreme volatility in energy this year.

While Wall Street has lowered its expectations for a spike in prices next year, strategists still largely expect oil to move higher in 2023, particularly due to predictions of higher demand as China reopens its economy after three years of COVID closures.

Economists at Goldman Sachs last week said the bank sees Brent crude oil — the international benchmark price — averaging $98 per barrel and WTI, the U.S. benchmark price, at $92 a barrel. Previous forecasts saw targets of $110 for Brent and $105 a barrel for WTI.

Emanuel, however, argued the comparison of energy stocks to oil prices is "misplaced.”

“If it weren't misplaced, we would have never bought an oil stock again in 2020 when the price of WTI turned negative," Emanuel said.

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Alexandra Semenova is a reporter for Yahoo Finance. Follow her on Twitter @alexandraandnyc

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