From The Wall Street Journal

Investors have been quietly moving into shares of energy companies, lured by the firms’ strong earnings growth and cheap valuations, as they aim to diversify beyond some of the big technology stocks that led the recent stock-market rout.

Energy companies have posted the strongest earnings growth of the 11 sectors in the S&P 500 in every quarter this year, according to FactSet. With third-quarter results in from all 29 companies in the sector, profits have more than doubled from the same period a year earlier. That compares with a 22% increase from other companies in the index, excluding energy.

Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, said she has been “patiently bullish” on energy stocks and has noticed a trend of investors moving out of technology stocks this year and into energy.

Ms. Calvasina said her firm has advised clients all year to increase their energy exposure and has recommended reducing tech positions since April.

Energy stocks, to be sure, have been on a wild ride. They have slumped 12% in the fourth quarter as crude-oil prices tumbled into a bear market—typically defined as a 20% fall from a recent high. But they have fared better since the beginning of November, posting a more modest 0.5% decline. Tech stocks, meanwhile, have tumbled 9.7% in the quarter to date and 1.8% in November.

“Energy has quietly gotten cheaper and cheaper,” Ms. Calvasina said. “People had their eyes glazed over when I would talk to them about energy in the first half of the year. But in the second half, there’s been more openness to it.”

The energy sector’s forward price/earnings ratio was 13.7 as of Thursday, down from 25.7 at the start of the year, while the S&P 500’s ratio was down to 15.6 from 18.1, according to FactSet.

Patrick Kaser, portfolio manager at Brandywine Global, said his firm nearly doubled its position in oil-field service provider Schlumberger Ltd. during October’s market selloff because of its attractive valuation.

Schlumberger’s shares have tumbled 28% this year and are hovering near their lowest levels since 2009. The company last month reported a double-digit profit increase, benefiting from stronger energy-development activity world-wide.

Another reason investors are looking at energy shares: They historically perform well during the latter part of an economic expansion as inflation and interest rates rise, according to Sam Stovall, chief investment strategist at financial research company CFRA. The Federal Reserve’s plan to continue tightening monetary policy through next year has boosted energy’s appeal, Mr. Stovall said.

His firm’s data show energy has been the second-best-performing sector, behind only technology, since 1970 in periods when the yield on the 10-year Treasury note rose from the prior month. Meanwhile, energy has been among the better-performing sectors in a bear market after consumer staples, health care and utilities since World War II, according to CFRA.

“Energy is like the fifth Beatle. Nobody remembers,” Mr. Stovall said.

But a recent rise in the dollar and oversupply concerns in the oil market have dented some of the enthusiasm for the energy sector. U.S. oil prices have tumbled 26% from their Oct. 3 high and recently suffered their longest losing streak since 1983 amid worries of excess supply.

Even so, Bill Costello, senior portfolio manager at Westwood, said his firm increased its exposure to small-cap energy stocks such as Callon Petroleum Co. , Jagged Peak Energy Inc.and WPX Energy Inc. in October and early November. He said he thinks those stocks are trading at a big discount to where crude-oil prices will be over the longer term.

“Commodity-price movements like this, which cause stock prices to collapse, are opportunities for us to add to positions,” Mr. Costello said.

But there is one thing Mr. Costello said could change his view on energy stocks: signs of a further slowdown in oil demand because of a strong dollar or a weaker global economy.

Other portfolio managers are also watching to see whether the dollar’s climb will set the stage for a perfect storm in the oil market. A stronger dollar makes buying dollar-denominated oil more expensive for holders of other currencies outside the U.S. The WSJ Dollar Index, which measures the U.S. currency against a basket of 16 others, has climbed 4.7% in 2018 and is up 1% this month.

Tim Seymour, founder and chief investment officer of Seymour Asset Management, said the dollar has the potential to move even higher, pointing to political and economic tensions in Europe. He said that could spark a further decline in the euro, which has already shed 4.9% against the dollar in 2018.

“You can’t invest in a bad neighborhood,” Mr. Seymour said. “The question is whether energy is a bad neighborhood if the dollar moves appreciably higher.”

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