VEGO knows NOTHING,,,,,,,,,,,re:Chickens Coming HOME Utilities Have Been Soaring as Treasuries Get Crushed. That Isn’t Supposed to Happen.
By Jacob Sonenshine/BLOOMBERG
April 11, 2022
Investors often seek out utility stocks as a haven because demand for power is relatively stable. Above, a Consolidated Edison van in New York City.
Utility stocks have soared recently, while yields on Treasury bonds have done the same. The two aren’t supposed to rise at the same time—and now it seems utility stocks will struggle in the short run.
Normally, utility stocks and long-dated Treasury yields move in opposite directions. When the 10-year Treasury yield rises, it makes the dividend yield on a utility stock—a favorite option among people seeking steady payouts with little risk—relatively less attractive. That gives investors a reason to dump utility stocks.
At the same time, higher Treasury yields also reflect expectations for high inflation, a result of a strong economy, in the future. When the economy is growing briskly, investors often abandon utility stocks for those whose earnings are more likely to rise significantly in response to greater demand for goods and services.
That isn’t what is happening now: Utility stocks have risen alongside Treasury yields. The Utilities Select Sector SPDR exchange-traded fund (XLU) has risen just over 18% since Feb. 23, the fund’s low point after weeks of declines. The yield on 10-year Treasury debt, meanwhile, has jumped to 2.71% from 1.73% just after the end of February.
The rise in both utility stocks and Treasury yields makes sense given today’s economic landscape. Investors expect the Federal Reserve to reduce its bondholdings as part of an effort to raise interest rates on debt of all sorts—short- and long-dated—as it seeks to bring inflation under control. The potential that the central bank will hold less debt is weighing on prices for Treasurys, which sends yields higher.
The likelihood that the Fed’s efforts to control inflation will slow the economy significantly, perhaps bringing on a recession, meanwhile, is prompting investors to rush into defensive stocks like utilities, which see stable earnings growth even when economic growth slows down.
“The market expressed these macro fears through positioning with investors bidding up the more-defensive sectors,” wrote Christopher Harvey, chief U.S. equity strategist at Wells Fargo, mentioning utilities’ move higher.
Now, utility stocks appear to be due for losses in the near term. First off, at just under $77 a share, the utility fund trades at almost $10 above its 200-day moving average. That is, roughly speaking, the highest dollar amount above that average the fund has traded at since the late 1990s, according to BTIG data.
The shares’ explosive move away from their longer-term trend is a sign they are due to slide. “Utilities are likely to pullback in the near-term,” wrote Jonathan Krinsky, chief market technician at BTIG.
That makes sense given valuations of stocks in the fund. Its aggregate forward price/earnings ratio is about 10% higher than the 19.5 times for the S&P 500, according to FactSet. Utilities often trade at a slight premium to the S&P 500 during times of high economic uncertainty. In early March 2020, the utility fund traded at a multiple about 20% above the S&P 500’s; historically, utility valuations tend to peak right around this level.
If a pullback does come, buying some shares might make sense. The utility fund is expected to achieve aggregate earnings-per-share growth of almost 8% in 2023—and by the end of this year, the stocks will be reflecting that earnings stream.
The comparable figure for the S&P 500 is 10%, but earnings estimates for the S&P 500 could decline if the economy slows down. Morgan Stanley
strategists just upgraded the utilities sector to Overweight, partly because the sector has seen some of the lowest variation in their profit estimates out of all of the index’s sectors.
Utilities could provide portfolio protection once they pause from their recent run.