Utilities ETFs were the only U.S. sector in the green during Monday’s 100-point Dow sell-off with some analysts saying the sector’s recent plunge on concerns over tax hikes is overdone.
Utilities Select Sector SPDR (NYSEArca: XLU) was up 1.5% in morning action. It was the only one of the nine Sector SPDR ETFs that managed to post a gain.
XLU has been punished in the wake of the presidential election on fears the utilities sector will be hurt if the lower 15% tax on qualified dividends is allowed to expire at the end of the year. [Utilities ETFs Turn Negative for Year on Dividend Tax Worries]
“There is clearly concern among many that tax policy in the U.S. concerning dividends will change for the worse for holders of equities that traditionally spin out hefty dividends, and it is likely no coincidence that this sector has taken it on the chin following President Obama’s re-election,” says Paul Weisbruch at Street One Financial.
Utilities ETFs are also seen as a defensive portfolio play since the industry is known for its stability and above-average dividends. [Utilities ETF Plunges on ‘Tremendous’ Volume, Dividend Tax Concerns]
Heading into Monday’s utilities sector rally, XLU was down 5.5% for the trailing three months, versus a 1% gain for SPDR S&P 500 (NYSEArca: SPY), according to Morningstar.
“In the long-run, though, the warnings about dividend taxes may be overblown,” ETF Base said in a commentary over the weekend. “Relative to corporate bond yields, utilities are undervalued. Dividend yields in utility companies are on par with investment grade corporate debt yields. This goes against historical norms – utility yields usually came at a discount to corporate debt yields.”
XLU has a dividend yield of 4.2%, according to manager State Street Global Advisors. SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEArca: ITR) is yielding 3.2%.
“Furthermore, utilities offer inflation protection,” according to ETF Base. “While higher inflation rates leads to lower utility company valuations, utilities are paid based on how much capital they deploy in regulated markets. Therefore, inflation in the cost to build new power plants means more capital at work and more capital earning a guaranteed return for regulated utility investors.”
Other ETFs for the sector include Vanguard Utilities ETF (NYSEArca: VPU) and iShares Dow Jones US Utilities (NYSEArca: IDU).
Utilities Select Sector SPDR
Full disclosure: Tom Lydon’s clients own SPY.