Utilities Stocks Expensive, but Standing Tall

This year, however, it’s warranting the price of admission, as it’s the second-best sector in the S&P 500, trailing only energy — an impressive feat when considering utilities’ historical negative correlations to rising interest rates.

Equal-weight strategies are getting in on the act. For example, the Invesco S&P 500 Equal Weight Utilities ETF (RYU A) is up 3.11% year-to-date, as of May 13, beating its cap-weighted rival by 332 basis points.

This surge “leaves utility stocks trading at almost 20 times forward 12-month earnings on average—close to an all-time high and nearly a fifth richer than the S&P 500. The last time utilities fetched such a large premium was during the Covid-19 market panic in March 2020. The staid sector has typically traded at a slight discount to the broader index over the past decade,” reported Jinjoo Lee for the Wall Street Journal.

In a vacuum, RYU’s 2022 performance makes the exchange traded fund appealing. However, that allure is enhanced by the specter of a possible recession. If economic growth materially contracts, investors are likely to embrace already-shaky growth stocks and equities levered to discretionary spending. Rather, the steady business model offered by the utilities sector is attractive in uncertain economic environments. Rounds of corporate actions may have bolstered the defensive nature of RYU and its member firms.

“In recent years, utilities have become much simpler, having sold or spun off units that are riskier than or less related to their regulated, monopoly business. Exelon, for example, spun off earlier this year a business unit that has exposure to competitive electricity markets. CMS Energy last year sold off a bank subsidiary,” according to the Journal.

Indeed, RYU’s stout performance this year is a surprise. As noted above, the sector — often seen as a bond proxy — tends to lag when interest rates rise. Additionally, high inflation is usually a drag on this cost-intensive sector. In other words, RYU and other utilities ETFs are defying the odds this year.

Still, the S&P 500 Utilities Index yields 3.1%, or 17 basis points ahead of 10-year Treasuries. Among equity sectors, only energy sports a higher dividend yield. Bottom line: Now is a good time to consider the utilities sector, but if markets rapidly improve and risk appetite returns, that could change.

“With investors seemingly finding new worries around every corner lately, the forces holding the rest of the market back can make utilities look like a hidden jewel one moment and a lump of expensive coal in the next,” concluded the Journal.

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