As U.S. stocks plunged Wednesday, a familiar sector provided some refuge for investors. Utilities and the Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities sector exchange traded fund, performed significantly less poorly than the broader market Wednesday.
Even with concerns about higher interest rates, the rate-sensitive utilities sector has been solid this year as highlighted by a year-to-date gain of almost 7%.
Utilities stocks and ETFs are extremely sensitive to changes in interest rates. Still, some investors see opportunity with rate-sensitive assets such as XLU and real estate ETFs, noting that 10-year yields are overbought and sentiment against the likes of XLU is at bearish extremes, which could create opportunity from the long side with the utilities sector.
Barclays analyst Blerina Uruci noted: “A return to more seasonally normal temperatures occurred in March, leading to a 8.2% rebound in utilities production on the month. We see the more modest increase in April as a return to the normal run rate,” reports Crystal Kim for Barron’s.
XLU yields about 3.3% on a trailing 12-month, making it and rival utilities ETFs popular alternatives to lower-yielding bond funds. The sector, one of the smallest sector allocations in the S&P 500, is also one of the least volatile. However, those favorable traits do not come free. As previously mentioned, utilities are highly sensitive to interest rates. Additionally, the sector often trades at a premium to the broader market due to its high yield and defensive traits.
“XLU’s ability to hang tight is “interesting” given the pressure that has been put on real estate, notes Instinet technical analyst Frank Cappelleri. More importantly, he said that if the S&P 500 hits below 2380 and the XLU breaks out simultaneously could mean that “the environment is indeed changing,’” according to Barron’s.
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.