Can Utilities in the 'Bond-Esque' Sector Offer the Best of Both Worlds?

The Utilities Select Sector SPDR (NYSEArca: XLU) and other utilities exchange traded funds are usually thought of as low beta, defensive assets, but some analysts are highlighting the utilities sector as a Covid-19 recovery destination.

Utilities are typically more stable stocks since the demand for their services, notably electricity and gas, is steady from both consumers and businesses. Moreover, in a lower-for-longer yield environment, utilities come with more attractive above-average dividends.

XLU YTD Performance

While the coronavirus pandemic predictably crimped power demand, the utilities sector is forecasted to deliver steady growth over the next decade.

“Still, we remain more bullish than most industry forecasts even while assuming that energy efficiency remains a fierce headwind,” according to Morningstar. “Electricity is set to take share from other energy sources, such as coal, oil, and eventually natural gas. This offers utilities long-term infrastructure investment opportunities, supporting our 5.5% annual earnings growth outlook for the sector.”

The XLU ETF in the ‘Bond-Esque’ Sector

After recent bouts with volatility, investors are still looking at the bond-esque sector as a safe way to remain the game and generate some extra dividends on the side.

Over the near-term, XLU and rival utilities ETFs could be supported by a compelling technical outlook. The MSCI ACWI Multi-Utilities Index, is starting to gain in short-term strength with the 50-day moving average rising above the 200-day moving average. Looking further ahead, there are other encouraging fundamentals to consider.

“We expect electricity demand to bounce back to prepandemic levels next year as the economy recovers. In the long run, we continue to believe electricity demand will break out of a decade-long slump. U.S. electricity sales have been flat since the 2008-09 recession,” according to Morningstar.

Investors should also consider the positive impact disruptive technologies and emerging industries will have on the utilities sector.

“Our growth estimate for new sources of electricity demand adds 20 basis points to our annual demand growth forecast. We estimate data centers, electric vehicles, and cannabis cultivation electricity use will represent 18% of new electricity demand during the next decade and grow to 5% of total U.S. electricity use by 2030, up from 3% now,” concludes Morningstar.

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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.