ETF Trends
ETF Trends

Conservative utilities stocks and sector-related exchange traded funds have been the best performing area of the market this year. However, the outperformance has made this defensive segment rather pricey.

Year-to-date, the Utilities Select Sector SPDR (NYSEArca: XLU) increased 23.3% while the SPDR S&P 500 ETF (NYSEArca: SPY) gained 5.4%.

However, the impressive rally this year has left the sector overextended, with elevated valuations, causing some analysts to warn of a possible bubble, MarketWatch reports.

XLU currently shows a 18.69 price-to-earnings and a 1.87 price-to-book. The S&P 500 Utilities Sector is showing a 12-month forward price-to-earnings ratio of 19, compared to its 10-year average of 14 and will above the PE of 16.4 for the broader index.

The utilities sector is trading at heightened valuations after investors plunged into the defensive play in search of yield and safety in an environment of historically low yields, slow growth and geopolitical uncertainty.

Related: Will the Utilities ETF Sector Keep Shining?

“It’s a simple macro trade, when rates are falling and there is global uncertainty investors buy defensive and domestic sectors like utilities,” Diane Jaffee, senior portfolio manager at TCW, told MarketWatch.

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Looking ahead, FactSet projects the utilities sector is expected to experience earnings growth of 4.4% in 2016. Consequently, analysts warned that the lofty prices may not be supported by robust earnings growth.

The trailing 12-month PE ratio for utilities of 19.85 is now higher than that of the more volatile technology sector at 19.16.

Related: Safe-Haven ETFs for a Rocky Summer

“The last two times when utilities rallied in the face of falling interest rates—for example in 2011-12 and late 2014, a sudden rebound in rates resulted in the collapse of utilities,” Jaffee added.

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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.