“The sharp rise in interest rates, in line with our outlook, appears to be the primary factor weighing on market valuations,” said Morningstar. “The 10-year U.S. Treasury yield recently rose to 2.85%, the highest since January 2014, making utilities’ income properties less attractive. The spread between the 10-year U.S. Treasury yield and the utilities sector’s 3.3% trailing 12-month dividend yield is the tightest since January 2003 and approaching its 25-year average (16 basis points). The spread was 118 basis points as recently as mid-November.”
Additionally, the utilities sector has not gotten much of a boost from tax reform. On the note of tax reform, the benefit to utilities is muted because, as regulated industry, utilities will be forced to pass cost savings from tax reform onto consumers.
“Utilities’ key fundamental risk is a potential cut in regulated returns, which would reduce our earnings growth outlook. However, regulators have been slow to pull back allowed returns in a persistent low-interest-rate environment. Rising interest rates and tax cuts will take some pressure off regulators to cut utilities’ allowed returns,” according to Morningstar.
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