The Utilities Select Sector SPDR (NYSEArca: XLU), Vanguard Utilities ETF (NYSEArca: VPU) and the iShares U.S. Utilities ETF (NYSEArca: IDU) have all posted double-digit losses this year, but the pain for the utilities sector might not be over.
It goes a little something like this for utilities stocks and exchange traded funds: Treasury yields rise and the utilities sector falls. With market participants pricing in an interest rate hike from the Federal Reserve, perhaps as soon as September, the rising yields/slumping utilities sector scenario is playing out. [Crunch Time for Rate-Sensitive ETFs]
“And the carnage may not be over. Utilities stocks’ price/earnings ratio relative to the S&P 500 has dropped to around 91% today, from about 107% at the start of the year. But that remains well above the 73% average seen between 2000 and 2006. That still leaves utilities looking overcharged as rate increases draw closer,” reports Spence Jakab for the Wall Street Journal.
The utilities sector usually trades at a premium to the broader market. That is the cost of playing defense and grabbing the sector’s tempting dividend yield (XLU’s trailing 12-month yield of 3.42% is more than 100 basis points above where 10-year yields closed Thursday).
While XLU has endured its worst stretch in six years, the rate-sensitive iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) experienced one of the worst 16-week rate of change declines in its 13-year history. Long-term bonds are most at risk of a rate hike. For instance, TLT shows a 17.7-year duration – duration is a bond fund’s measure of interest rate sensitivity. Consequently, a 1% rise in rates could translate to about a 17.7% decline in TLT’s price. In contrast, bond funds with shorter durations would have a lower sensitivity to rate changes. [Bearish Bond ETFs Back in Style]