Even with concerns about higher interest rates, the rate-sensitive utilities sector has been solid this year. For example, the Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities sector exchange traded fund, is up 10.3% year-to-date.
Some market observers believe the sector, prized for its high dividend yield and defensive traits, can keep delivering upside as 2017 moves along.
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.
“On a chart of the utilities-tracking ETF XLU, Evercore ISI Technician Rich Ross points out that the sector has broken out of a “12-month base of support” with XLU forming a “bull flag” over the last few months, a pattern that normally precedes another rally. According to Ross, these short-term technicals are pointing to potentially $60 for utilities, a 12 percent rally from Tuesday’s levels,” reports CNBC.
The First Trust Utilities AlphaDEX Fund (NYSEArca: FXU), a smart beta spin on utilities, is another utilities ETF to consider. FXU is up almost 5% this year.
Like the other AlphaDEX funds, FXU is “based “on growth factors including three, six and 12-month price appreciation, sales to price and one year sales growth, and, separately, on value factors including book value to price, cash flow to price and return on assets,” according to First Trust.
“The XLU has a dividend yield of more than 3 percent, which is significantly above that of the S&P 500 and of the U.S. 10-year Treasury note. Stocks with high yields often rise when interest rates fall, since the lower yields in the bond market can make holding high-dividend stocks a more attractive prospect,” according to CNBC.
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.