Defensive sectors, such as consumer staples, telecom and utilities, often traded at multiples that are richer than the broader market. That is the price to pay to play defense. However, there are times when these sectors become expensive even relative to their historical norms.
The Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities exchange traded fund, is the top asset gatherer among the nine sector SPDR ETFs to start this year. Additionally, XLU and rival utilities ETFs have recently been among a small number of ETFs to consistently make new highs.
Utilities sector fundamentals remain strong. However, utilities have been underforming due to the sector’s inverse relationship to rising interest rates – when rates rise or investors fear higher rates, utilities typically underpeform, and vice versa.
Most investors view utilities as a reliable, income-generating asset that exhibit some bondlike characteristics. As interest rates declined, the sector appealed to many income investors for its relatively higher yields.
Still, investors should be leery of viewing the utilities sector as a value play.
“Big utility stocks trade at an average of 17 to 18 times projected 2016 earnings, which isn’t cheap considering annual industry earnings growth is generally in the low- to mid-single-digit range. The sector now trades at a premium to the S&P 500, which fetches about 16 times estimated 2016 operating earnings. The utilities ETF (ticker: XLU) yields 3.8%, compared with 2.2% for the S&P,” according to Barron’s.
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]
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 this month, the rising yields/slumping utilities sector scenario is playing out. [Crunch Time for Rate-Sensitive ETFs]
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.
Utilities Select Sector SPDR
