Encouraging Signs for Utilities ETFs

  • SPDR, largest utilities ETF, is up nearly 7% this year
  • Utilities have been under-performing due to rising interest rates
  • Big utility stocks trade at an average of 17 to 18 times projected 2016 earnings
  • Mark Newton, of Newton Advisors, says he ‘expects the rally in utilities to extend’

The Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities exchange traded fund, is up nearly 7% this year, good for one of the best performances among major sector exchange traded funds. Although the utilities sector is viewed by some as richly valued, investors may not want to bet against XLU and rival utilities ETFs.

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 bond-like 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.

While XLU and rival utilities ETFs do not scream “value,” the good news is the charts for the group could be saying more gains are on the way.