The utilities sector usually is not associated with excitement, but the sector is on a roll and is breaking out on a technical basis. The Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities sector exchange traded fund, is up 8.4% year-to-date and more than 2% over just the past week.
Previously, 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. The bond-esque utilities sector has also weakened alongside the fixed-income market as Treasury yields rose on the Fed outlook and inflationary pressures.
The good news is that investors keep gobbling up U.S. Treasuries and many bond market observers are betting the Fed does not have the latitude to raise rates again this year, which would be a boon for utilities stocks and ETFs.
“The past few days of outperformance for XLU are highly interesting because utilities are traditionally a countercyclical sector. Utes seem to be breaking out here as the yield curve narrows,” reports ETF Daily News. “The yield curve, of course, illustrates the difference in interest rates between short term bonds (typically 2-Year Treasuries) and long term bonds (10-year Treasuries). The spread between these two benchmark interest rates has shrunk to a post-election low of just 97 basis points, mostly as a result of the 10-Year yield falling significantly.”
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. XLU currently resides just a few cents below its 52-week high.
“While no one’s quite sure why bonds are acting like they are, higher-yielding sectors like Utilities seem to be benefitting, as the bond market signals that more interest rate hikes this year are getting increasingly unlikely. The dividend yield for the S&P Utilities Sector currently sits around 3.5%, which is a massive 123 basis points above the current yield on the 10-Year Note,” according to ETF Daily News.
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.
For more information on defensive ETFs, visit our defensive ETF category.