With market-based indicators increasingly pointing to a global recession, the utilities sector is poised to outperform the broad market.
The U.S. economy avoided another quarter of contraction during Q3; however, forward-looking indicators are signaling that a recession may be looming. The two- and 10-year Treasury yield spread has been negative for four consecutive months, and the Leading Economic Index (LEI) year-over-year growth fell deeper into negative territory, according to Bloomberg.
History suggests that utilities will be better positioned amid an economic slowdown. Utilities have shown a more stable earnings outlook given their defensive business nature and strong capability to pass costs to consumers, according to FactSet.
“During times of market uncertainty, advisors have benefitted from the steady cash flow generation and dividend payments provided by utilities,” VettaFi head of research Todd Rosenbluth said. “These companies are less sensitive to economic developments and can provide a relatively safe haven.”
The utilities sector may be notorious for underperforming during periods of economic recovery and expansion, but it is a top performer during recessionary periods. Utilities have outperformed the broad market in all previous recession periods by an average of 11%, according to State Street Global Advisors SPDR. The sector also has the lowest downside capture across all GICS sectors, giving the sector the potential to help portfolios navigate a volatile market environment.
While not as top-heavy as other sectors, the utilities sector is still largely concentrated in its top five names. NextEra Energy Inc. (NEE), Duke Energy Corporation (DUK), Southern Company (SO), Dominion Energy Inc. (D), and Sempra Energy (SRE) currently make up over 41% of a market cap-weighted utilities sector ETF.
In contrast, the Invesco S&P 500 Equal Weight Utilities ETF (RYU ) gives each security an equal weight at each quarterly rebalance, meaning five securities will make up roughly 15.6% of the fund after each rebalance. Investors look to equal-weight strategies to reduce concentration risk in a portfolio and increase diversification.
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