You should always have energy stocks in your 401(k). Yes, even when oil is at $100.

By Brett Arends

Energy and resource stocks have zigged while the market has zagged

Saudi-backed forces shoot at Iranian-backed rebels in Yemen - but please don't call it a war.

If you want to see the reason for owning a specialist energy or natural-resources stock fund in your 401(k) - alongside the regular stock and bond funds recommended by conventional wisdom - check out the latest news on Wall Street.

Once again, it's a tale of two markets.

Oil and commodities are booming. Oil (CL00) (BRN00) just broke $100 a barrel for the first time since July, as the "I wouldn't call it a war" war drags on and on. Energy and resources stock funds are making gains.

Meanwhile, most other stock and bond indexes are sluggish, flat or down.

So far this year, the State Street Energy Select Sector SPDR ETF XLE - a low-cost and broad-based index fund of major U.S. energy companies such as ExxonMobil (XOM) and Chevron (CVX) - has made a 47% return. The State Street SPDR S&P Global Natural Resources ETF GNR, which invests across the board in other commodity stocks as well - such as those involved in the mining and production of copper (HG00), iron, precious metals and agricultural chemicals - has risen 29%.

Meanwhile, the State Street SPDR S&P 500 ETF Trust SPY has earned 13%; the Invesco QQQ Trust QQQ, an index fund that follows the Nasdaq-100 NDX, is up 17%; the Vanguard FTSE Developed Markets ETF VEA, an index fund that invests in advanced-economy stock markets outside the U.S., is up 18%; and the iShares Core U.S. Aggregate Bond ETF AGG, one of the most popular index funds that invest in bonds, is down about a third of a percentage point, even including dividends.

All this is before you deduct fees, taxes and the impact of inflation.

Even better, so far this year, energy and resource stocks have zigged while the market has zagged - producing their biggest gains just when bonds, and other stocks, have most taken a pounding. Energy stocks were up in March, when the stock and bond indexes fell. They're up again now.

As a result, those who have an energy fund in their retirement account, alongside stock and bond index funds, have enjoyed the investors' holy grail: bigger gains, and smoother returns.

Like that annoying guy on the radio commercial, we hate to say we told you so - but, well, we told you so. (See here, and here, and here).

But if this were about one day, or one week, or one month, or one year, or even one war, this wouldn't be particularly useful news. Many or most 401(k) investors (generally wisely) pick a portfolio and don't tinker with it. And it would be a dangerous game to recommend something because it has recently gone up in price (and is therefore more expensive), even though that's often how investors think.

This may not seem the best moment to buy energy (that was probably April 2020, when oil futures infamously went negative), but this isn't simply about short-term market movements or trading.

The case for including some energy stocks or natural-resources stocks in your portfolio isn't because of the war in the Middle East or any short-term outlook for oil prices. It's a long-term argument.

For over 25 years, going back at least since the start of this millennium, having a simple energy index fund (or an equivalent) inside your retirement account, alongside your regular stock and bond funds, has been a winning move. It's made you more money, and reduced your risks.

During that time, the typical "balanced portfolio" of 60% U.S. stocks and 40% bonds, as tracked by the Vanguard Balanced Index Fund VBINX, has earned you an average of 7.1% a year (before costs, and without adjusting for inflation to reflect the shrinking value of a dollar DXY). But a portfolio that was 90% invested in VBINX and 10% in XLE has earned you an average of half a percentage point a year more, or 7.6% a year.

And it's involved less risk, or at least volatility. It's produced better average returns over one-, three-, five-, seven-, 10- and 15-year periods. And its worst performances have been less bad than the worst performances of the straight stock-and-bond fund.

Notably, energy did well when stocks and bonds both did badly in 2022, following the Russian invasion of Ukraine. As the XLE fund earned a stellar 64% that year, including a 10% allocation to the fund cut overall portfolio losses nearly in half, from 17% to 9%.

Energy also did well when U.S. stocks (though not bonds) did badly during the lost decade of the 2000s.

Going further back, energy also did very well during the 1970s, when stock indexes and bonds did very badly.

On the other hand, when energy has done badly, it has usually been while stock indexes and bonds have done well.

Back in February, we showed that this has been pretty much the case going back since the 1920s, using the famous database of stock-market performance managed by Dartmouth finance professor Ken French.

Two years ago, Jeremy Grantham - the celebrated, self-described "permabear" who co-founded Boston fund company GMO - pointed out that natural-resources stocks had the lowest long-term correlation with the rest of the stock market of any sector.

"Natural resources," incidentally, is a broader category that goes beyond just energy stocks. It also includes the stocks of metals and mining companies, and often those involved in the production of agricultural-related minerals as well.

As they invest across multiple commodity sectors, natural-resources funds tend to be lower risk than pure-play energy funds. Oddly, they often have higher fees. For example, the XLE charges only 0.08%, whereas the State Street SPDR S&P North American Natural Resources ETF NANR charges 0.35%. If you go for globally diversified funds, the iShares Global Energy ETF IXC charges 0.37%, and the State Street SPDR S&P Global Natural Resources ETF charges 0.4%.

All of this makes basic intuitive sense. Energy is a costly and unique input into economic production. And the new AI data revolution is making energy more important, not less. AI data centers, like crypto miners before them, are energy hogs. When energy prices go up, energy companies benefit. And when broader commodity prices go up, natural-resources companies benefit.

But almost everyone else loses. Inflation rises, which is bad for bonds. Household costs rise, which means consumers have less money to spend on everything else. Company costs also rise, which is bad news for corporate profits and for hiring.

Meanwhile, when energy and commodity prices crash, natural-resources companies lose out - but pretty much everyone else benefits. Suddenly, companies see their costs plunge. Consumers find their gasoline and heating bills collapse. Airplane tickets become much cheaper. And so on.

All of which is simply an intuitive explanation for something that has already been demonstrated mathematically: Energy and resources stocks have done well precisely when your regular stock funds, and usually your bond funds, are doing badly. According to Portfolio Visualizer data, since the XLE was launched in 1999, it has had a low 55% monthly correlation with the Vanguard Balanced Index Fund, which consists of a portfolio of 60% U.S. stocks and 40% U.S. bonds.

That, roughly, means that when the VBINX goes up or down in any particular month, there is only a 55% chance that the XLE will do the same thing.

A fund like the XLE has several advantages over other energy and commodity investment options. It's simple, transparent, lower risk and with lower fees. Complex commodity-futures funds, which try to invest in commodity prices directly, can be the opposite.

Even long-term investors may be understandably reluctant to buy into an energy fund at current levels. How much of the booming oil price is already reflected in the high price of energy stocks? They will surely suffer a pullback if the Trump administration decides that midterm U.S. voters might prefer cheaper gasoline instead of hazy plans to, say, invade Iceland.

One alternative is always to buy slowly and in stages, minimizing the painful risk of buying right at the peak.

Alternatively, you could check out two smaller closed-end funds, BlackRock Energy & Resources Trust BGR and Adams Natural Resources Fund PEO, which invest in energy and related stocks, have very good long-term track records and are still - for some reason - selling for substantial discounts to their underlying net assets. BGR, which is run by the world's biggest fund-management company and which invests globally, sells for about 11% below underlying net assets - which means at current stock prices, you are paying about 89 cents for every dollar of underlying investments. PEO, which invests almost exclusively in U.S. energy and related companies, sells for about 9% below NAV, or 91 cents on the dollar.

Closed-end funds are regulated mutual funds, just like ETFs and the funds in your company's 401(k) plan - but they trade like stocks, with the result that their share price often falls below the fund's intrinsic value. This can often be a bargain.

These discounts show that Wall Street continues to be skeptical about the oil price boom so far, to its cost. Those with some energy exposure have been sleeping easier.

-Brett Arends

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09-09-26 1627ET

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