Ten-year Treasury yields have fallen by more than 10% over the past month, but that has provided little relief to utilities stocks and exchange traded funds.
Over that period, the Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities ETF, has lost 0.2%. Down 5.7%, XLU is the worst performer among the nine sector SPDR ETFs this year. However, not all market observers are rushing to bash the utilities sector and XLU. For example, AltaVista Research rates XLU neutral, a rating that is not as tepid as it sounds.
“Average appreciation potential. A rating of NEUTRAL is assigned to funds with ALTAR Scores between 6.0% and 8.0%. This indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category,” said the research firm in a recent note.
“In late January, the median U.S. utilities valuation hit the highest level ever since Morningstar began covering utilities,” according to Moringstar‘s director of utilities equity research. “The February swoon cut that premium in half. We also cut our cost of capital assumption in our discounted cash flow valuations to reflect historical inflation and real interest rates, bringing valuation premiums down another 10%. As of mid-March, utilities’ median valuation was only slightly above market prices and in line with valuations in late 2013 before the 27% run in 2014.” [A Contrarian View of Utilities ETFs]
That is to say XLU is not as richly valued as it usually is. In fact, AltaVista estimates XLU’s 2015 P/E ratio to be 16.6, just ahead of the Technology Select Sector SPDR (NYSEArca: XLK) and behind four other sector SPDRs.
Still, there is that pesky sensitivity to interest rates to consider with utilities ETFs. Dividend-paying utility stocks are a more attractive alternative when bond yields decline. However, market observers argue that yields are more likely to fall than rise in the current market environment, which could start to weigh on the utilities sector. [Trouble for Rate-Sensitive ETFs]