As is the case with consumer staples counterparts, utilities exchange traded funds, such as the Utilities Select Sector SPDR (NYSEArca: XLU), roared higher in the first half of this year as investors favored defensive, low beta, income-generating segments of the equity market.
In fact, XLU spent significant time earlier this year as the best-performing sector SPDR ETFs. However, the largest utilities ETF is lower by nearly 3% over the past month amid a confluence of concerns, namely that the Federal Reserve will soon raise interest rates and that defensive sectors, including utilities, are overvalued.
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The fortunes of the utilities sector seem to be tied to the Federal Reserve’s interest rate outlook. Once the Fed eventually hikes interest rates, the higher rates will make fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.
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.
[related_stories]However, just like staples, some market observers believe the utilities sector is now oversold.
“In bull markets that lack momentum (today), the right strategy is to buy oversold conditions, not chase strength. That often requires a controversial call, and one that may be at odds with recent data. Today that call is buying utilities (and bond surrogates), while fading/selling banks. The former is oversold, with spiking 65-day lows and negative volatility alerts suggesting tactical liquidation,” according to a Renaissance Macro Research note posted by Amey Stone of Barron’s.
Related: Will the Utilities ETF Sector Keep Shining?
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.
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.
For more information on defensive ETFs, visit our defensive ETF category.
Utilities Select Sector SPDR
