As the S&P 500 notched another all-time high this morning and artificial intelligence stocks continue their relentless march higher, one sector sits conspicuously at the bottom of the 2025 performance rankings: energy. The dramatic dispersion between the market’s leaders and laggards has created what may be an attractive entry point for contrarian investors.
The Energy Paradox
Energy has delivered strong returns over the past five years, yet 2025 has been a different story entirely. Despite the new administration’s explicit “Drill baby, Drill” policy stance and stated commitment to domestic energy production, the sector has underperformed dramatically while the broader market reaches new highs.
This disconnect between policy support and stock performance creates an unusual situation. Political rhetoric favors the sector, fundamental economics remain solid, and yet investor sentiment has turned decidedly cautious. The third day of the current government shutdown has done little to rattle markets, with the VIX holding near 16 as equities continue melting higher.
Sector Concentration Creates Opportunity
The Energy Select Sector SPDR Fund (XLE) provides the most direct exposure to the sector, though investors should understand its concentrated nature. Three companies dominate the fund’s holdings: Exxon, Chevron, and ConocoPhillips represent nearly 50% of total exposure. This concentration amplifies both risk and potential reward.
Rather than viewing this concentration as a flaw, it may represent an advantage. These three energy giants are established leaders with diversified operations, strong balance sheets, and direct importance to U.S. energy security. Their market positions appear secure regardless of short-term policy fluctuations or sentiment shifts.
Why Now for Energy
Several factors suggest energy’s underperformance may be nearing an end. The government shutdown, while disruptive in many ways, could paradoxically support risk assets if it reinforces the Federal Reserve’s inclination to cut interest rates. Administration officials have indicated plans to use the shutdown to reduce government employment, potentially extending what some are calling “DOGE 2.0” efficiency initiatives.
Lower interest rates typically benefit energy companies by reducing financing costs for capital-intensive operations and making dividend yields more attractive relative to fixed income alternatives. Energy stocks currently offer some of the highest dividend yields in the S&P 500, yet remain out of favor with momentum-focused investors chasing technology gains.
The Risk-Reward Setup
Current valuations in energy appear compelling relative to both historical norms and other sectors. While the S&P 500 trades near record highs with elevated valuations across growth sectors, energy stocks remain reasonably priced despite strong underlying fundamentals.
The sector’s underperformance in 2025 has created a situation where patient investors can establish positions at attractive levels. For investors willing to look where others aren’t, the current setup offers asymmetric risk-reward dynamics that are increasingly rare in today’s market environment.
Strategic Considerations
Energy exposure makes sense as a portfolio diversification tool even without assumptions about sector outperformance. The negative correlation between energy stocks and technology leadership creates natural hedging properties that can reduce overall portfolio volatility.
Additionally, energy companies have significantly improved their capital discipline compared to previous cycles. Management teams across the sector have prioritized returns to shareholders through dividends and buybacks rather than pursuing growth at any cost. This disciplined approach should support valuations even if commodity prices remain range-bound.
The Comeback Thesis
Sector rotation is a normal part of market cycles. Technology and artificial intelligence stocks have dominated 2025 performance, creating extreme concentration in market leadership. History suggests these periods of narrow leadership eventually broaden as investors seek value in overlooked areas.
Energy’s position as the third-worst performing sector in 2025 positions it well for potential catch-up gains if broader market rotation occurs. The combination of policy support, reasonable valuations, attractive yields, and oversold sentiment creates multiple potential catalysts for improvement.
Looking Forward
The current market environment favors momentum and growth, leaving value-oriented sectors like energy in the shadows. However, the factors that have driven energy underperformance appear more sentiment-driven than fundamental. Political uncertainty and concerns about economic growth have overshadowed the sector’s solid underlying economics.
For investors with a contrarian bent and patience for sectors trading at discounts to the broader market, energy presents an interesting opportunity as we close out the trading week. The extreme dispersion in 2025 sector performance suggests mean reversion could favor current laggards in the months ahead.
Whether energy rebounds sharply or simply stops underperforming, establishing positions in out-of-favor sectors trading at reasonable valuations has historically proven to be a sound long-term strategy. Sometimes the best opportunities are found exactly where nobody else is looking.
