Defensive sectors often trade at premium valuations relative to the broader market and that is certainly the case at the moment with the utilities sector and exchange traded funds such as the Utilities Select Sector SPDR (NYSEArca: XLU).
However, that does not mean investors should flee richly valued groups such as consumer staples and utilities. In fact, the case for these higher-yielding sectors could be getting a boost as bond markets are pricing in diminishing chances of the Federal Reserve boosting interest rates later this month while also reducing the odds of a July rate hike.
Related: Paying For Protection
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.
The Fed “essentially wants to confirm improvement in the economy and labor markets before pushing rates higher too quickly. The quarter-point increase in interest rates may not have a significant impact on the rates investors see at banks and in money market funds. The Fed’s next rate hike may not come quickly, leaving investors to continue searching for higher yields. In the equities markets, sectors such as consumer staples and utilities have histories of being more conservative than the broader market while offering investors above-average yields,” according to Investopedia.
[related_stories]Low interest rates in the U.S. have sent investors flocking to dividend stocks and exchange traded funds in recent years. With central banks throughout the developed world paring rates and engaging in monetary easing, government bond yields are falling, giving investors good reason to consider high yield dividend 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.
Related: Surging Utilities ETFs
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.
“The high cash flow nature of utilities has historically warranted a below-market price-to-earnings (P/E) ratio due to their traditional lack of growth. Recent strong performance by the utility sector has pushed its valuation level to nearly on par with that of the S&P 500. As of May 27, 2016, the Utilities Select Sector ETF’s P/E ratio of 17 was nearly even with the S&P 500’s ratio of 18 and far above the P/E ratio of 12 the fund had in 2011,” adds Investopedia.
Utilities Select Sector SPDR
