Energy: The Wildest Sector in Today’s ETF Market

Saying that energy stocks are volatile is like saying water is wet. And while we’d rather get splashed with water than crude oil or gasoline, the energy sector of the stock market is once again proving to be one of the most interesting “playgrounds” for investors. To help understand why, consider the following:

• What sector had the biggest drawdown (peak-to-through loss) of the 11 S&P 500 sectors since the pandemic top of Feb. 19, 2020?
• Other than technology, the confirmed performance leader since that same date, which sector has performed the best?
• Since the start of 2022, when the Fed started a rate hike cycle that didn’t stop until it had raised rates 11 times, what was the top sector by performance?

The answer to all three questions above is the energy sector.

XLE and Energy Sector Volatility

Using the $38 billion fund that is the largest in the energy patch, The Energy Select Sector SPDR ETF (XLE), its return since that pandemic top in 2020 is more than 17% annualized. Since the very start of 2022, its 26% annual return rate is far and away the best, as tech and industrials are next at under 10% each. Yet it also had the biggest drop over that time, a 56% “haircut.” 

Put this all together, and it is no wonder market pundits seem to always be talking about the next energy stock rally, even if it doesn’t come around for a while. This sector is notoriously volatile, tied strongly to the price of oil, but also includes some of the best cash flow generating businesses around. 

Looking Beyond XLE for Energy Exposure

Furthermore, whereas many sectors only offer a few ways to differentiate themselves away from their sector SPDR, XLE is just one corner of the energy ETF business. So, let’s look briefly at a set of alternatives to simply plugging in the biggest and most prominent ETF in this wide-ranging part of the global economy. This space is way too limited to cover it in depth, so here is a glimpse of what segments can be researched.

Energy MLPs are essentially the underground highway systems that transport oil and gas from where it is found to where it can be used. The biggest ETF in this industry is the $9 billion Alerian MLP ETF (AMLP), but it has plenty of peers. 

The fossil fuel business can be divided into three separate but interrelated functions. Energy is drilled for, refined into products, and consumed. ETFs exist to cover both end points as well as the so-called “midstream” stocks. 

Clean Energy ETFs Provide Potential Diversification

Then, there are the clean energy ETFs. They are large in number and diverse in focus, including the $2 billion iShares Global Clean Energy ETF (ICLN) and niche players like the $190 million First Trust Global Wind Energy ETF (FAN). These alternatives to traditional fossil fuel ETFs often behave differently than that “old guard” in the energy sector, which can help with portfolio diversification.

This allows financial advisors and self-directed investors to potentially reduce single stock risk, while spreading their opportunity set in the vast and complex energy sector. Energy is the stuff of which wars are fought, consumers struggle with (in times of high gas prices) and which stock market investors can profit from, in a variety of ways, through ETFs.