With concerns about rising interest rates creeping back to the forefront of investors’ minds, the Utilities Select Sector SPDR (NYSEArca: XLU) is lower by more than 3% over the past month in what could be a sign that sector investors are betting the Federal Reserve will raise interest rates following its December meeting.
Over the long-term, the utilities sector could continue to generate steady profits as the industry expands operations. According to S&P Capital IQ Equity Analyst Christopher Muir, the utilities industry is experiencing high levels of capital spending on regulated capital spending through infrastructure replacement, new transmission and distribution facilities, and regulated power plants. Additionally, unregulated spending will focus on natural gas-fired combined-cycle power plants and investments in solar and wind.
Still, some investors see opportunity with rate-sensitive assets such as XLU and real estate ETFs, noting that 10-year yields are overbought and sentiment against the likes of XLU is at bearish extremes, which could create opportunity from the long side with the utilities sector. [Rethinking Rate Sensitive ETFs]
Although utilities stocks and ETFs are vulnerable to the notion of higher interest rates, how the group performs after the Fed actually boosts borrowing cost is another, surprisingly positive matter.
“Declining utility stocks are a harbinger of rate increases as the sector tends to underperform the broader market when rates are rising, Kit Konolige, a Bloomberg Intelligence senior utilities analyst, said by phone Nov. 16. Raising rates “may well become appropriate” at their December meeting, the FOMC said in minutes of the October meeting released Wednesday,” reports Jim Polson for Bloomberg.
Looking at the utilities profit outlook, Capital IQ estimates that the sector could post earnings growth of 0.9% for the third quarter and 1.7% for all of 2015.
In contrast, the S&P 500 is expected to see earnings decline of 4.5% for Q3, which was downwardly revised since the start of the third quarter, according to FactSet data, as energy and multinational sectors weighed on the broader index. Those data points underscore the predictable though often slow-growth profit outlooks seen in the utilities sector.
“The average utility dividend yield has risen to 4.02 percent from 3.96 percent on Sept. 16, another sign that investors expect a rate increase. It had dropped to 3.68 percent on Oct. 22 after the Fed left its target rate at zero percent to 0.25 percent,” according to Bloomberg.
Utilities Select Sector SPDR
The opinions and forecasts expressed herein are solely those of Tom Lydon, 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.