Up 15.5% year-to-date, the Utilities Select Sector SPDR (NYSEArca: XLU) is one of the best-performing sector exchange traded funds of any stripe, but with that impressive performance comes elevated valuations.
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.
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Further boosting the allure of utilities stocks and ETFs like XLU is the Federal Reserve’s ongoing reluctance to raise interest rates. The Fed passed on that opportunity earlier this year and the most recent batch of U.S. employment data could put make it hard for the central bank to boost rates this monnt or next month. Add all that up and it is easy to see why investors have flocked to XLU and rival utilities ETFs this year.
Although investors have displayed an obvious fondness for utilities stocks and ETFs like XLU this year, that affinity exposes investors to some frothy valuations.
Goldman Sachs notes “that regulated utilities now trade at a forward price-to-earnings ratio in excess of the S&P 500 based on estimated 2017 and 2018 earnings. That ratio is also elevated relative to the sector’s five-year average,” reports Bloomberg.
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.