The utilities sector was a dud last year, but that situation is improving and reminding risk-averse investors that assets such as the Utilities Select Sector SPDR (NYSEArca: XLU) are still relevant parts of diverse retirement portfolios.
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 dividends.
“Like many of us, utilities were happy to say goodbye to 2020. They lost all of their early-year momentum when the pandemic hit and have yet to recover,” according to Morningstar. “Utilities closed 2020 as the second-worst-performing sector behind energy and remain down 10% from their peak last February. After record-high valuations in early 2020, the sector pullback means more attractive valuations going into this year. Healthy balance sheets, secure dividends, and growing earnings should give investors comfort that utilities can play their traditional defensive, income-producing role in 2021.”
3 Catalysts for ‘XLU’
The XLU thesis isn’t just about turning the calendar. It has to do with low bond yields, improving dividend growth outlooks, and attractive valuations within the utilities sector.
“Utilities’ dividend yields and growth outlook have rarely been so attractive. The 220-basis-point spread between the sector’s 3.5% dividend yield and the 1.3% 10-year U.S. Treasury yield is near a 30-year high,” adds Morningstar. “The current spread is also well above the average 140-basis-point spread since interest rates began their secular decline during the last two decades.”
After recent bouts with volatility, investors are still looking at the bond-esque sector as a safe way to remain in the game, generating some extra dividends on the side. Investors can also take comfort in the positive impact disruptive technologies and emerging industries will have on the utilities sector.
Adding to the allure of XLU is the utilities sector’s increasing footprint in the fast-growing renewable energy arena.
“Utilities will be leading investors in renewable energy and supporting infrastructure like transmission and smart grids,” continues Morningstar. “The U.S. is set to add nearly 50 gigawatts of solar and wind generation capacity in 2021-23 based on planned or under-construction projects. That would bring U.S. solar and wind capacity nearly equal to coal generation capacity.”
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