Buy Energy Stocks to Hedge AI Exposure

The biggest game in town has been the AI-trade.

Stocks levered to memory, power, photonics, and infrastructure have risen spectacularly.

That doesn’t come without downside risks. There’s a way to protect yourself should the AI-trade falter.

Keep it simple: Buy energy stocks to hedge AI exposure.

Let’s call a spade a spade. The AI boom has been truly breathtaking.

The Philadelphia Semiconductor Index has quadrupled over the past three years, while the NASDAQ 100 has more than doubled.

There’s no sign the spending boom will end anytime soon…and for good reason.

AI applications require low latency, so data centers are being built closer to end users. That’s fueling huge worldwide AI capacity expansion.

Remarkably, US hyper-scaler AI capex is expected to surge 80% to $739B in 2026. J.P. Morgan forecasts a further ramp up to $895B in 2027 and $950B in 2028.

Even if rosy forecasts are met, pullbacks happen.

On May 4, we told you to buy into AI with leading names in semiconductors, hyper-scalers, power, construction, optics, and networking as AI Infrastructure Profits Double the S&P 500 Growth Rate.  

We’re still big believers in AI, but smart portfolio diversification always makes sense, especially after such a parabolic rip higher.

Today, we’ll show you why energy stocks are the perfect AI hedge.

We’ll unpack four meaty studies making the case to buy the big dip in the oil and gas patch.

After you review the evidence, you’ll see the layup opportunity ahead.

As always, we’ll wrap up with a top-tier list of 20 energy outliers seeing huge institutional inflows.

Buy Energy Stocks to Hedge AI Exposure

When you construct a portfolio, it’s important to have assets that behave differently.

As one area zigs, you want another pocket to zag.

This allows for diversification and helps with risk management.

Energy stocks fit the bill inside a concentrated AI portfolio.

Below you see how the S&P 500 energy sector has negative correlations to the Magnificent 7, the NASDAQ 100, the UBS AI Winners Index and the Philadelphia Semiconductor Index, respectively (chart).

A correlation of 1 indicates that two assets move in perfect unison together. When you have a negative correlation, those assets behave quite differently.

Energy stocks can jump when AI stocks dump:

If you’re concerned with potential summer volatility, there’s no better way to hedge your semiconductor exposure than high quality energy outliers.

The hedging story gets even better.

Energy Stocks Hedge Against the Biggest Macro Risk to AI: Rising Rates

The biggest macro threat to the AI trade is sticky core inflation and rising interest rate rates… including potentially tighter Fed monetary policy.

Year-over-year core PCE hit 3.3% in April, a three-year high.

Meanwhile, 10-year Treasury yields are up to 4.45% from just 4% when the war began, as sticky oil prices fan inflation fears.

2-year yields - the best proxy for the Fed funds rate - are up to 4.06% from 3.5% pre-war, signaling market expectations the Fed’s next move is a rate hike.

The good news is energy stocks can hedge AI rate risk. Oil & Gas names trend higher when rates rise.

Here’s the proof:

The S&P 500 energy sector has the highest positive correlation to 10-year Treasury yields of any sector at 0.32 (chart).

That means that energy stocks generally move in the same direction as interest rates.

The same can’t be said for AI stocks.

Technology and communications sectors are negatively correlated to 10-year bond yields with 10-year trailing monthly correlations of -.12 and -0.09, respectively.

When rates rise, especially when it’s quick, big tech has historically declined while energy equities have gone up.

If you’re concerned about rising rates, own black gold:

Let’s shift gears to the 3rd reason to buy energy stocks now.

Oil & Gas Stocks Offer Compelling Value

The best time to buy insurance is when it’s cheap. Energy stocks definitely check the value box.

Oil names are down big since peaking in late March as crude has drifted lower on hopes for an end to the Iran war and a reopening of the Strait of Hormuz.

The energy sector is now the cheapest in the market at only 13X 12-month forward EPS, down from 21X in late March.

This represents the widest valuation gap vs its cycle peak.

Below are all S&P 500 sector valuations in relation to their respective cycle peak:

Valuations matter.

Earnings will fuel a re-rating for the group.

Energy’s Earnings Power is Underappreciated

While energy stocks are down about 10% since peaking in late March, their valuations are down 30%.

The reason? Earnings are exploding higher.

Energy stocks are forecasted to post 65% earnings growth this year, by far the strongest in the S&P 500. Technology is a distant, second at 43% (chart).

The bear case on petroleum names is that their earnings momentum is unsustainable. Pundits claim an end to the war in Iran will quickly normalize oil prices back down to pre-war levels in the mid-60s.

The reality is that there’s been such a disruption to global energy supply chains and geopolitical relationships that oil prices will take much longer than expected to normalize.

We’re likely looking at structurally higher oil prices above $70 for at least the next couple of years.

That’s a highly profitable level for US operators. Even though the rule of large numbers means that earnings growth will inevitably slow from 65%, absolute profitability will remain at record highs.

At 13X forward earnings, that’s not priced into the sector.

Throw in a 3% dividend yield, the ability to hedge the AI trade and rising interest rates, and you’re staring at a recipe for success and a great portfolio diversifier!

Now let’s drill down to an actionable portfolio allocation.

What This Means for Your Portfolio

HALO (heavy asset, low obsolescence) stocks are still in charge.

Energy checks the HALO box.

Despite easing geopolitical fears, energy remains very well bid on weakness.

After a long run on top, it still owns the #2 spot in MoneyFlows sector rankings, second only to technology:

Today’s stock list features energy names with the highest MAP Scores in the sector.  

Inflows have been constant, powering most of these names to one record high after another.

Under-the-surface of the market is a world of hidden opportunity.

To get access and make even more from this call to action, sign up for a PRO membership.

You’ll get our proprietary indicators and learn how our unique money flow approach finds outlier stocks early. Give it a shot!

If you’re a money manager or RIA and want portfolio solutions and deep ETF insights, reach out about our Advisor solution here.

Be early next time.

Go with the flows!

Energy outliers remain well bid across E&P, refining, midstream and integrated names.

Below, for PRO subscribers, is a list of 20 large-cap, winning energy stocks with big money activity.