The U.S. economy is chugging along, with employment numbers strengthening. However, the improved economic environment is fueling bets that the Federal Reserve will hike interest rates next month, dragging on rate-sensitive utilities sector exchange traded funds.
The utilities sector was among the worst performing areas of the market Friday. The Vanguard Utilities ETF (NYSEArca: VPU) fell 3.8%, iShares U.S. Utilities ETF (NYSEArca: IDU) declined 3.9% and Fidelity MSCI Utilities Index ETF (NYSEArca: FUTY) dropped 3.7%. The utilities sector ETFs also broke below their 50- and 200-day moving averages Friday.
Utilities plunged after the stronger-than-expected jobs report added to speculation that the Fed would raise short-term interest rates for the first time in almost a decade. U.S. companies added 271,000 new jobs in October, the fastest pace for the year, and the employment rate fell to 5% from 5.1%, the lowest levels since April 2008, reports Jeffry Bartash for MarketWatch.
Moreover, the government revealed an acceleration in wages, with hourly pay rising at its fastest year-over-year pace since the U.S. rose out of the recession.
“The October jobs report is a virtual blockbuster,” Dan North, chief economist at Euler Hermes, told MarketWatch.
Fed Chair Janet Yellen has stated that December would be a “live possibility” for an interest rate hike if the U.S. economy continues to strengthen.
Utility stocks have been gaining traction in a near-zero interest rate environment as investors flocked to higher yielding assets. For instance, VPU has a 3.54% 12-month yield, IDU has a 3.43% 12-month yield and FUTY has a 4.17% 12-month yield, whereas the yield on benchmark 10-year Treasuries is 2.33%. However, the utilities sector was hardest hit area Friday as a rate hike would make these riskier bond proxies less attractive.
“Longer-term, in a rising-rate environment, investors should expect flat returns at best for utilities companies and underperformance when compared with other equity sectors,” according to Morningstar analyst Robert Goldsborough. “Higher rates generally make fixed-income instruments more attractive on a relative basis and make bondlike equities, such as utilities companies, less attractive.”
Vanguard Utilities ETF
For more information on the utilities sector, visit our utilities category.
Max Chen contributed to this article.