As the Fed eventually hikes interest rates, the higher rates will make fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.
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.
Still, some utilities stocks, including several of XLU’s marquee holdings, stand to benefit as the move to more environmentally friendly power generation takes hold across the U.S.
“Utilities operating in states with constructive regulation and environmental policy support could realize 7%-9% annual earnings and dividend growth the next three to five years. Best positioned are utilities like Dominion Energy, Duke Energy, American Electric Power, and CMS Energy that are investing billions of dollars in new infrastructure. NextEra Energy and Xcel Energy should widen their lead as the top U.S. renewable energy companies,” notes Morningstar.
For more information on defensive ETFs, visit our defensive ETF category.