The Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities sector exchange traded fund, is up almost 4% this month, making it one of August’s best-performing sector funds. XLU and some rival utilities ETFs have recently been hitting new highs, but that should not imply the run is over for the often tame utilities sector.
As the Fed continues raising 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.
However, the utilities sector has largely shrugged off two Fed rate hikes this year. XLU is up nearly 13% year-to-date. It, along with the Vanguard Utilities ETF (NYSEARCA: VPU) and the Fidelity MSCI Utilities Index ETF (NYSEARCA: FUTY) were three of the ETFs to hit all-time highs on Tuesday.
“Equities in the utilities space, typically seen as defensive plays and bond proxies given their high yields, have rallied this year for several reasons, but one driver in particular sticks out to Chad Morganlander, portfolio manager at Washington Crossing Advisors,” reports CNBC. “Mergers and acquisitions in the space, as well as deregulation, have propelled the sector (and a popular utilities-tracking exchange-traded fund, the XLU) to new heights this year, Morganlander pointed out.”
Investors should note before departing ETFs like XLU that the utilities sector is historically one of the best-performing groups in the month of September. Year-to-date, utilities are the third-best sector in the S&P 500, trailing only technology and healthcare.
“Morganlander, who carries an overweight to neutral position on utilities, believes the ‘long end’ of the yield curve, or the benchmark 10-year Treasury yield, will likely go lower and perhaps even hit 2 percent as economic growth appears to slow. If that occurs, utilities will ‘continue to have a bid underneath it’ and find support,” notes CNBC.
Related: Utilities ETFs In Fed Focus Again
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.
XLU has seen third-quarter inflows of nearly $367 million. VPU has seen modest inflows in the current quarter.
For more information on defensive ETFs, visit our defensive ETF category.