Energy Stocks Still a Portfolio Hedge

Summary

In this article, Russ Koesterich examines why energy stocks could remain a portfolio diversifier in 2026 amid evolving earnings trends and market conditions.

Key takeaways

• With rising rates reducing bonds' diversification benefits and assets like gold and the U.S. dollar offering limited protection, energy and energy stocks remain one of the few effective portfolio hedges in 2026.
• Since late February, energy stocks have exhibited a notably negative correlation to the broader market, while also benefiting from the strongest earnings momentum across sectors on both a one- and three-month basis.
• While the economy has so far absorbed rising oil prices relatively well, a more significant spike could hurt consumer spending and growth, shifting investor concerns from inflation to recession and ultimately reducing energy demand.

2026 has been a good year for stocks but a difficult year for building multi-asset portfolios. In periods when stocks sold off, it has often been due to rising rates, which have made bonds an ineffective hedge, often adding to risk rather than mitigating it. At the same time, other diversifying assets, such as gold and the dollar, have either struggled or shown little diversification benefits. That, as I discussed last spring, leaves energy and energy stocks the last hedge standing.

Outside of AI-related angst, year-to-date the other catalyst for investor selling has been rising energy prices, and the knock-on effect to interest rates. Since the start of the war with Iran, the correlation between West Texas Intermediate (WTI) crude and the S&P 500 has been approximately -0.45.

For those who might respond that oil and stocks generally move in opposite directions, the historical data suggests otherwise. Between 2000 and 2025 the correlation between U.S. stocks and oil has been positive 0.25. While this seems counterintuitive, there is an underlying economic logic. A strong economy boosts demand for oil as well as corporate earnings, explaining why oil and stocks often move in tandem. The current negative correlation is one of the most extreme we’ve seen since the first Gulf War in the early 1990’s.

The negative correlation between the stock market and oil extends to energy stocks as well. Since late February, the correlation between the S&P 500 energy sector and the broader market has been approximately -0.6. Put differently, on days when stocks are falling, energy stocks are often one of the few asset classes rising.

Not just a hedge

Apart from offering hard to find diversification, energy stocks are also distinguished by their earnings. On both a one and three-month basis, the sector has the highest earnings momentum (see Chart 1).

Chart 1
Global sector earnings momentum

The risk is an energy induced slowdown

While higher energy prices are obviously supportive of the earnings and relative performance of the sector, at some point the relationship shifts and higher energy prices choke off demand. Thus far, the economy has been resilient to rising oil for several reasons. Inflation adjusted oil prices are not that extreme relative to past cycles. In addition, the economy is also less energy intensive. In other words, energy is a smaller percentage of overall economic activity.

That said, a more dramatic spike in energy would represent a bigger economic headwind at a time when higher interest rates are already pressuring many households. In that scenario, investor fears may quickly shift from higher oil to recession, bringing down demand and oil prices. So far, higher energy prices have not been enough to kill growth, but at some price that balance begins to shift. Until then, I would continue to remain overweight in this sector.

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