Key Takeaways
A standoff in the Middle East that threatens to choke off a critical oil artery is forcing investors to reassess a sector they have shunned for years. With the S&P 500’s energy component already up 33% year-to-date, a prolonged period of high oil prices could make energy stocks an essential portfolio hedge against inflation, despite their sharp run-up in valuation.
"The more visible energy gets, the riskier an underweight position gets," Dan Pickering, chief investment officer of Pickering Energy Partners, said. Investors have been underexposed to the sector for years, with more funds flowing out of energy-sector ETFs than into them since 2021, according to data from State Street Investment Management.
The sudden rally has pushed the S&P 500 energy sector to a forward earnings multiple of around 17.5 times, a significant premium to its 15.8 times multiple at the end of 2025 and its five-year average of about 13 times. In contrast, the previously high-flying tech sector has fallen more than 7% this year. Even after its recent outperformance, the energy sector constitutes less than 4% of the S&P 500’s market capitalization, a far cry from the 25% it represented during the inflation shocks of the 1970s.
The core of the issue is the potential for a sustained closure of the Strait of Hormuz, a vital channel for global oil supply. "If the U.S. leaves abruptly with Iran in control of the waterway, it is all but inevitable that fighting will resume in the region," said Bob McNally, president of Rapidan Energy Group, calling the situation an “unsustainable equilibrium.” This disruption means the world will likely face a structurally higher oil-price environment, with global inventories draining by "upwards of half a billion barrels or more," according to Rory Johnston, an oil-market researcher at Commodity Context.
For years, investors avoided energy stocks due to their poor returns during the shale boom, a focus on growth over profits, and concerns over climate change. That era of profligate spending is over, as a wave of consolidation has left a smaller group of larger, more disciplined producers. Furthermore, the best shale inventory has already been drilled, limiting the industry's ability to quickly ramp up production as it once did.
Historically, the energy sector has been the most effective shield against rising prices. An analysis from Hartford Funds covering 1973 to 2025 found that during periods of high and rising inflation, oil-and-gas companies beat inflation 74% of the time, delivering an average annual real return of about 12.9%. As investors who were "lulled to sleep by the long period of time without inflation shocks" now awaken to new risks, the case for rotating back into energy becomes more compelling, notes Tim Murray, a capital-markets strategist at T. Rowe Price.
This article is for informational purposes only and does not constitute investment advice.
