Click to Enlarge Utilities might not be the most interesting sector to talk about at cocktail parties, but right now, boring could hardly be working any better.
During May, the Select Sector Utilities SPDR (NYSE:XLU) rose 0.6% even as the SPDR S&P 500 ETF (NYSE:SPY) was hit for a loss of 6%. Not surprisingly, utilities were the only major sector to close the month in positive territory.
This isn’t the first time utilities have outperformed during a period dominated by concerns about Europe. In the 2010 selloff (which ran from May 3 to July 2), XLU’s return of -7.72% far outpaced the -14.68% loss for SPY. The following year, SPY took dive of -17.89% from July 22 through Oct. 3, but XLU only lost 1.96%.
And that’s not all. Since its inception in December 1998 — an interval with no shortage of crises and bear markets — XLU has produced a return more than double that of SPY: 84.5% versus 36%. Notably, XLU also would have outperformed during this time period even without the benefit of dividends.
The ability to hold up well during a crisis clearly has been a positive attribute in recent years, and it remains so today. In fact, utilities offer investors everything they’re looking for right now.
The majority of their revenues are generated domestically, which helps insulate the sector against the more problematic growth outlook for Europe and Asia. Utilities’ input costs have been falling rapidly because of the downturns in both coal and natural gas prices, which has helped earnings estimates for the 10 largest utilities either to rise or hold within a few pennies during the past 90 days. The collapse in U.S. Treasury yields has been an additional positive. The yield on the 10-year Treasury has plummeted from 2.38% on March 19 to below 1.5% currently, making the 3.6% yield on utility stocks (as gauged by the XLU) look increasingly attractive on a relative basis.
While all of these factors are undoubtedly positive, they pale in comparison to the most important attribute of all: utilities’ defensive nature. Defensive stocks have held up extremely well so far this year, and utilities — as the 800-pound gorilla of the defensives — has been a leading beneficiary. As a result, there’s no reason to expect that utilities can’t continue their run of outperformance as long as investors remain frightened by headline risk.
Click to Enlarge However, keep in mind this doesn’t necessarily translate to positive absolute returns: Utilities were crunched along with the rest of the market in 2008, losing nearly 29% on the year, so it’s not safe to assume the sector is immune to a “disorderly” exit by Greece from the euro.
Still, it’s telling that XLU is on the cusp of a 52-week high despite the travails of the rest of the market. XLU was trading at $35.77 at mid-day on Friday, less than a 2% move away from surpassing high-water mark of $36.27 hit in late December. It’s a great signal for utilities — but unfortunately, it’s also a sign of the times for the rest of the market.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.