This Defensive Sector Appears Undervalued | ETF Trends

It appears the perfect storm against utilities stocks and the related exchange traded funds remains in place. Interest rates are high. Growth stocks are leading the market and inflation, though easing a bit, remains a drag on this capital-intensive sector.

Still, the S&P 500 Utilities Index is higher by 1.17% year-to-date, which isn’t bad considering the aforementioned headwinds facing the sector. The Invesco S&P 500 Equal Weight Utilities ETF (RSPU) has outperformed the cap-weighted benchmark by a modest margin year-to-date. Some market observers believe recent strength, albeit modest, by utilities stocks could be the precursor to something more substantial.

One reason for that constructive view is that the sector is trading at discounts. In low interest rate environments, utilities stocks typically traded at elevated valuations due to their above-average yields. However, that scenario often reverses course when rates rise.

Stars Could Be Aligning for RSPU

Valuation isn’t the only reason for investors to evaluate RSPU. The equal-weight utilities ETF is also underpinned by solid sector-level fundamentals and expectations that at some point this year, the Federal Reserve could start lowering interest rates.

The potential rate catalyst for utilities remains to be seen. But it is an election year and President Biden recently signaled that he’d like to see the Fed lower rates. Bond market participants have dialed back expectations that the Fed will begin lowering rates this month. However, if inflation data continues to cool, RSPU and utilities stocks could get long-desired rate relief later this year.

Additionally, the longer-ranging fundamental outlook for the utilities sector is sturdy with contributions from the group’s exposure to the renewable energy transition.

“And fundamentally, when you talk to our equity analysts, they think the utilities space is as strong as they’ve ever seen it. They see a long runway of growth here for the transition into renewable energy,” noted Morningstar analyst Dave Sekera.

Another factor that could favor RSPU as 2024 moves along is that regardless of electoral outcomes in November, Congress and the White House have no choice but to address ailing grid infrastructure in the U.S. It’s a matter of national security and related spending could be a boon for RSPU member firms.

“We’re seeing a lot of government investment in the electrical grid infrastructure. That should all provide some pretty good growth for the utilities space over the next couple of years. Plus, we do think that the tailwind behind declining interest rates will be positive for them over the next few years,” concluded Sekera.

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