Utilities ETFs Show Signs of Life Thanks to Fed

It may not be the best sign for broader market risk appetite, but there are indications that utilities exchange traded funds, a beloved asset class for part of last year, are steadying after sliding into the end of 2016.

Utilities exchange traded funds, such as the Utilities Select Sector SPDR (NYSEArca: XLU), had an interesting 2016, morphing from leaders to laggards as investors’ expectations regarding the Federal Reserve’s interest rate policy shifted.

When all was said and done, XLU was one of 2016’s more solid sector ETF bets, but it limped into year end as the Fed rolled its first interest rate hike of 2016 in December. In anticipation of higher interest rates, XLU and rival utilities ETFs languished on the basis that 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.

“Investors may also be also lowering expectations about FOMC rate hikes in 2017. Fed governors are meeting this week, with no policy changes expected because the new administration has been in place for less than two weeks while policy implantation can take months or years to wind its way into monthly economic statistics. Also, the market already priced in more vigorous growth during the post-election rally and now needs actual metrics to underpin the rally,” according to Investopedia.

No sector is as negatively correlated to rising interest rates as utilities, meaning the longer the Fed resists raising interest rates, the longer high-yielding utilities stocks and ETFs remain compelling destinations for yield-starved investors.