Utilities ETFs Could be in For a Rough 2018

The Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities sector exchange traded fund, stumbled to end 2017 with a December loss of almost 7%. Some analysts believe the utilities faces additional challenges in 2018.

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. The Fed raised interest rates in December, its third such move in 2017 and several more rate hikes are forecast for 2018.

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.

“On a global basis, the utilities sector had a 1.08 market-cap-weighted price/fair value ratio as of Nov. 30, unchanged from the third quarter. A swoon in December brought down U.S. utilities’ valuations, but prices remain rich,” according to Morningstar.

An issue for utilities stocks and ETFs is that Treasuries are closing the yield, meaning conservative income may be more compelled to embrace bonds over the utilities sector.