Cloud Looms Over Surging Utility ETFs

August 30, 2017

The stock market may have hit a road bump in the month of August, but one sector has quietly bucked the trend.

Geopolitical tensions surrounding North Korea and fading optimism about tax reform weighed on the S&P 500 during the month, yet those same factors helped power utility ETFs to a new all-time high.

Utilities are currently the third-best-performing stock market sector of 2017, behind only technology and health care. The Utilities Select Sector SPDR Fund (XLU) has returned 15.5% in the year-to-date period through Aug. 28, compared with the 10.4% gain for the SPDR S&P 500 ETF Trust (SPY) in the same time frame.

 

YTD Returns For XLU, SPY

 

Risk-Off

A combination of "low yields and a risk-off market" is supporting the rally in utilities, according to Shar Pourreza, a utilities analyst at Guggenheim Partners. According to Pourreza, a lot of investors are nervous about the "the general market valuation, U.S. policy inertia, and geo-global macro concerns."

Considered a safe-haven sector, utilities tend to outperform when investors are jittery. They also offer large dividends―the aforementioned XLU was last yielding around 3.2%, compared with 1.9% for SPY. That makes them great for investors seeking income, but also makes them interest rate sensitive.

Utilities are often valued based on bond yields. When bonds climb and interest rates fall―as they typically do when investors are nervous―utilities become more attractive (and vice versa). The benchmark U.S. 10-year Treasury yield briefly fell to 2.08% Tuesday, a nine-month low, and well below the 2.44% level at which it started the year.

The current spread between Treasury yields and utility yields is 1.06% in favor of utilities, equal to average of the past decade.

 

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