Are Utilities ETFs Overvalued on Dividend, Safety Trades?

June 26th at 12:03pm by John Spence

ETFs following the U.S. utilities industry have outperformed the market by wide margin since the beginning of April with nervous investors favoring defensive sectors and dividends.

However, some analysts think investor fears over the Eurozone debt crisis are overblown and that utilities have been bid up to overvalued territory.

“The love for dividends and love for the bear trade is in many ways a form of insanity when growth expectations are so disconnected because of the negative narrative,” wrote Pension Partners chief investment strategist Michael Gayed in a recent MarketWatch article.

He notes the utilities sector has a forward price-to-earnings (P/E) ratio that is higher than technology. “This is illogical when we are not in a recession in the U.S. based on current data, and when we are not in a 2008-like environment,” Gayed writes. [Utilities ETFs Outperforming on Stability, Dividends]

Utilities Select Sector SPDR (NYSEArca: XLU) has a forecasted fiscal year P/E ratio of 15.1, compared with 12.6 for Technology Select Sector SPDR (NYSEArca: XLK), according to State Street Global Advisors, which manages the ETFs.

The utility ETF has a dividend yield of nearly 4%.

Some analysts were questioning the rally in early June because utilities, a conservative sector, were outperforming the market. [ETF Chart of the Day: Utilities]

Gayed notes that other defensive sectors such as consumer staples and healthcare are the most richly valued. [Consumer Staples ETFs for Defense]

Meanwhile, aggressive sectors such as industrials, financials and energy are among the “cheapest” sectors from a pure valuation standpoint.

“Income has become very expensive, while growth has become very cheap,” he said.

The chart below shows the relative performance of the utilities ETF versus the S&P 500.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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