Experienced investors know that utilities is one of the sectors most inversely correlated to interest rates. That explains why the S&P 500 Utilities Index slipped 7.2% last year amid spikes by 10-year Treasury yields.
With that index off nearly 5% to start 2024, the sector isn’t giving investors much to cheer about as of yet. But there are reasons to believe ETFs such as the Invesco S&P 500 Equal Weight Utilities ETF (RSPU ) could be ready to snap out of their doldrums.
The fund, which follows the S&P 500 Equal Weight Utilities Plus Index — as is the case with cap-weighted rivals — offers investors access to a basket of typically low volatility, high dividend names. Those dividends are sources of allure with the typically defensive sector, but act as a drag when interest rates rise. That’s the cost of admission with utilities stocks and ETFs.
Why RSPU Can Rebound
Utilities stocks are often viewed as value plays because they don’t offer growth comparable to the technology or communication services sectors. However, the reality is when utilities stocks are generating upside, valuations often get somewhat rich because of the sector’s favorable dividend and volatility traits.
Due in part to last year’s interest-rate-induced slump, defensive utilities stocks — including plenty of RSPU components — now sport value traits. In fact, based on Morningstar metrics, the sector is one of the most undervalued today.
“The utility sector sold off last year as interest rates rose, but we think the market has overcorrected to the downside. We think the fundamental outlook for utilities is as strong as ever,” noted Morningstar’s Dave Sekera. “The transition to renewables and focus on shoring up infrastructure for the electric grid provides the sector with a long runway for growth.”
Of course, valuation isn’t the only reason to embrace or eschew utilities stocks and ETFs such as RSPU. Interest rates are integral in this equation. While it appears to be a coin toss regarding a March rate cut, such reductions could materialize in earnest in the second quarter and beyond.
“While our original base case was the Fed would begin cutting rates in March, we remain confident that inflation will be low enough to spur the Fed to begin easing monetary policy at either its March or May meeting,” added Sekera. “Our U.S. economics team continues to forecast that inflation will subside and that the April core PCE reading will drop to 2.1%. We are still forecasting a total of 150 basis points of cuts in 2024 and the federal-funds rate to end the year in a range of 3.75%–4.00%.”
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