The utilities sector is often thought of as a bond proxy, meaning it’s vulnerable to rising interest rates. Those vulnerabilities are on display this year, but investors should be careful about ignoring the sector at this point. At a time when markets are favoring defensive assets, the Utilities Select Sector SPDR Fund (XLU ) is among the exchange traded funds investors may want to evaluate in the fourth quarter and into 2023.
One reason to consider XLU over the near term is the increasing specter of recession. In a rough economic environment, XLU can keep investors engaged with equities while other sectors are apt to struggle.
“Although the US economy avoided another quarter of contraction in Q3, market-based forward-looking indicators are flashing recession warnings as the 10- and 2-year Treasury yield spread has stayed negative for four consecutive months, and the Leading Economic Index (LEI) year-over-year growth fell deeper into negative territory,” wrote Anqi Dong, senior research strategist at SPDR Americas Research.
There are other important points in favor of XLU. Despite the aforementioned interest rate headwinds, the ETF is outperforming the S&P 500 on a year-to-date basis by nearly 1,500 basis points as of November 2. Additionally and perhaps more importantly, XLU is living up to its low-volatility reputation. The ETF’s annualized volatility to this point in 2022 is about 300 basis points below that of the S&P 500, according to ETF Replay data.
Another perk offered by XLU is earnings stability. That’s an enviable, relevant trait at a time when some previously beloved high growth stocks are delivering disappointing profit updates.
“While analysts have been downgrading S&P 500 earnings estimates for both this year and next year amid an economic slowdown and persistently high inflation, utilities have shown a more stable earnings outlook given their defensive business nature and strong capability to pass costs to consumers,” added Dong. “The utilities sector also carries the lowest beta to the S&P 500 and the lowest downside capture across all GICS sectors. This may help investors navigate a volatile market environment with downside risks.”
The utilities sector, owing to its bond-like traits, is also known for delivering above-average levels of income, and the $15.25 billion XLU makes good on that promise. The SPDR ETF sports a distribution yield of 3.06%, which is more than double the dividend yield that market participants earn on S&P 500 ETFs and index funds.
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