Utility stocks have been significantly underperforming the market since interest rates began rising in May. These dividend-paying machines have been mired in a sideways trading range while the broader market has continued to hit new highs. However, last week’s Fed announcement that it was going to stay the course with its unending supply of quantitative easing has boosted demand for this defensive sector. The stabilization in interest rates likely has much to do with the upward surge of momentum for utilities, combined with investors pouring back into a market segment that is attractive from a valuation standpoint.
This sector is considered to be one of the most stalwart in terms of its base of established companies providing essential services to nearly every consumer in the country. My favorite ETF for monitoring the utility sector is the Utilities Select Sector SPDR
(NYSEARCA:XLU). This fund is made up of 33 companies and the top holdings include Duke Energy Corp
(NYSE:DUK), The Southern Co
(NYSE:SO), and Dominion Resources Inc
(NYSE:D). The expense ratio for XLU is a reasonable 0.18%, and its current 30-day SEC dividend yield is a healthy 3.94%.
For comparison’s sake, it’s worth noting that over the last three months, XLU is +5.04% while the SPDR S&P 500 ETF
(NYSEARCA:SPY) has gained 8.19%. Back in August, I wrote
that the unfavorable interest rate environment was severely hampering the upside potential for utilities along with REITs and preferred stocks. However, if we see interest rates decline from their most recent highs, it will form a supportive base for these companies and send yield-hungry investors flocking back into these stocks.
If XLU can continue to hold above its 200-day average and extend its current win streak, we will likely see a renewed surge above the July highs. Utilities stocks offer numerous benefits including historical low volatility combined with a very generous dividend stream. They are considered defensive in nature because of the non-cyclical nature of their revenue models and built-in consumer demand.
If you are searching for a higher yield for your portfolio, then you may want to consider the Reaves Utility Income Fund
(NYSEMKT:UTG). This actively managed closed-end fund focuses on a much broader interpretation of utility companies, which includes telecommunication stocks, master limited partnerships, and even preferred utilities stocks. The current indicated yield for UTG is 6.32% (distributed monthly), and it is trading at a discount of greater than 6% to its NAV. It should be noted that UTG does employ leverage to boost its yield, which can be both a blessing and a curse, depending on your appetite for risk.
With the broad market near its highs, utilities are without a doubt a more attractive value at these levels than other high-flying sectors of the market. If you currently own stocks in this sector, I would continue to hold them as long as they remain above their long-term trend-lines. New allocations can be made on modest pullbacks to increase exposure and enhance the yield on your portfolio. As always, I recommend using a stop loss to ensure that you don’t get caught up in any excessive declines.
Read more from David Fabian, Managing Partner at Fabian Capital Management:
Should You Buy the Highs?
Crunch Time for Gold Again
How to Build a Low-Cost ETF Portfolio
No positions in stocks mentioned.