Utilities stocks and sector-related exchange have underperformed despite the ongoing coronavirus-induced uncertainty, but this market segment could be a good way for more pessimistic investors to hedge against ongoing risks to this nascent bull run.
Year-to-date, the Utilities Select Sector SPDR (NYSEArca: XLU) dropped 3.1%, Fidelity MSCI Utilities Index ETF (NYSEARCA: FUTY) fell 4.7% and Vanguard Utilities ETF (NYSEARCA: VPU) decreased 4.3%. Meanwhile, the S&P 500 Index is up 5.0% so far this year.
Utilities stocks typically do well during an economic downturn as they meet essential services like electricity, gas, and water no matter what the environment looks like, and the sector churns out steady yields, which are especially attractive after the Federal Reserve cuts interest rates to help lift the economy out of a rut.
However, the current disparity between the utilities performance and the broader market seems to reflect the view that the economy has already rebounded. In comparison, over the last financial downturn, utilities outperformed the S&P 500 through the March 2009 lows and mostly maintained the lead for over a year.
“Back in 2007-2009, the business cycle took about 15 months. This time, it’s been condensed to a four-to-five-month period,” Jay Rhame, chief executive officer of Reaves Asset Management, told the Wall Street Journal. The Reaves Utilities ETF (NYSEArca: UTES) is also 3.2% lower year-to-date.
Rhame also argued that there is increased concern over inflation this time, which makes utilities a poorer hedge, after the Federal Reserve and the U.S. government pumped out trillions of dollars into the economy.
On the other hand, recent equity and fixed-income moves may leave an opportunity for the utilities segment. Specifically, some market observers argue that the stock market rally appears speculative since the coronavirus and the economic damage has not completely gone away, warning that the current reversal between utilities and the S&P 500 may be premature, especially with banks signaling the worst may yet to come.
Sean Heymann, utilities analyst at RNC Genter Capital Management, also argued that utility dividends offer an attractive alternative for income-seeking investors while bond yields are still hovering around record lows, which has widened the gap between the yield of 10-year U.S. Treasury notes and the dividend yield for the S&P 500 Utilities Index.
For more information on the utilities sector, visit our utilities category.