Differing Views on Utilities Sector ETFs

MarketsETF Trends

The Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities sector ETF, tumbled again on Tuesday, extending its one-week loss to about 5% and its year-to-date loss to about 9%. Some market observers have differing views on the sector.

Earlier this week, Morgan Stanley Chief U.S. Equity Strategist Michael Wilson raised his rating on the utilities sector to “overweight as the rise in interest rates has been priced into those names,” reports Seeking Alpha. His favorite names in the sector include XLU holdings, such as “American Electric Power (NYSE: AEP), FirstEnergy (NYSE: FE), NextEra Energy (NYSE: NEE).”

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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.

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.

Meanwhile, “Williams Capital analyst Chris Ellinghaus says the firm urges utility investors to remain cautious through late winter as the sector faces headwinds including valuations, a rising interest rate cycle and potential inflationary pressures amid what’s likely to be the ‘final leg in a bear market.’” reports Seeking Alpha.

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.

XLU yields about 3.3% on a trailing 12-month, making it and rival utilities ETFs popular alternatives to lower-yielding bond funds. The sector, one of the smallest sector allocations in the S&P 500, is also one of the least volatile.

“Ellinghaus expects a further 7%-9% drop in utility stock prices before valuations look much more attractive in early spring,” according to Seeking Alpha.

Year-to-date, investors have added $87.5 million to XLU.

For more information on market sectors, visit our sector ETFs category.

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