As has been duly noted since the start of 2020, the energy sector is struggling and is by far the worst performer among the 11 groups represented in the S&P 500. Conversely, the utilities sector and ETFs, such as the Utilities Select Sector SPDR (NYSEArca: XLU), is thriving.
That presents a potentially interesting scenario. As the energy sector’s market value erodes and utilities’ rises, the two sectors could trade places in terms of prominence in the S&P 500.
As of Feb. 25, the SPDR S&P 500 ETF (NYSEArca: SPY) allocates 3.63% of its weight to energy stocks and 3.59% to utilities, according to State Street data. Only real estate and materials have smaller allocations in the benchmark equity gauge than utilities.
Interesting Defensive Scenario
Utilities are typically seen as a defensive sector or a more steady area of the market to ride out the volatility. These companies typically offer the most fundamental necessities, such as food, water, and shelter, or are closely related to the energy required to refrigerate food, heat up water and light up a house.
“The two sectors closed out a Tuesday to forget with weightings barely 4 basis points apart. All else equal, for energy to shrink below the weighting of utilities, oil and gas stocks need only drop another 1.2%,” according to Bloomberg. “The sector’s down almost 9% so far this week.”
The utilities sector was also one of last year’s best-performing areas, underscoring the notion that many investors will embrace utilities and related ETFs during favorable interest rate environments after the Federal Reserve cut interest rates three times.
The sector also provides a steady dividend, providing investors with a bond-esque income return. Furthermore, in a lower-for-longer interest rate environment, the yields on utilities makes them that much more attractive to income-minded investors.
Regarding energy, “the biggest factor may lie somewhere between the immediacy of relative sector sentiment and the existential challenges of the future. As observed in everything from Exxon Mobil Corp.’s dividend yield (hitting a new high of 6.4%) and the increasingly junky spreads in energy high-yield bonds, coronavirus has hit an industry weakened by its prior excesses,” reports Denning for Bloomberg.
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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.