There are reasons utility stocks are among the safest in the market during a recession: They provide stable dividends, and consumers cannot go without electricity and gas, even during economic downturns.
The Vanguard Utilities ETF (VPU) holds shares of the leading U.S. utility companies and pays an attractive dividend.
Since the March 2020 pandemic-inspired stock market lows, the trend in utility stocks and VPU has been higher, providing investors with steady dividends and capital growth, the best of both worlds.
Meanwhile, inflation tends to work against utility stocks because when interest rates are higher, investors tend to flock to fixed income instruments instead of stocks.
However, when utility stocks drop, the yields move higher. As the markets currently face inflation, recession and uncertainty in energy markets, the upward trajectory of utility stocks and VPU continue to make them attractive for investors.
VPU Trench Remains Bullish
The latest July consumer and producer price indices revealed that inflation subsided only slightly: It remains a clear and present economic danger.
July CPI rose 8.5% on a year-over-year basis, down from the 9.1% June reading. July PPI moved 9.8% higher, after an 11.3% rise in June. The data showed that U.S. inflation remained at a four-decade high.
Meanwhile, in the second quarter, U.S. GDP fell 0.9% after a 1.6% decline in Q1. This fit the economics textbooks’ definition of a recession as two successive quarterly GDP declines. And the elevated inflation data and GDP decreases also point to a stagflationary period in the U.S. economy.
The rally in utility stocks has continued, with VPU reaching a record high in August 2022.
VPU holds a portfolio of the leading U.S. utility companies, diversifying and mitigating the risks of holding individual utility shares. VPU has offered investors the best of both worlds—an attractive dividend yield and capital appreciation—which looks set to continue, as stagflation and geopolitical tensions support higher energy prices and increased profits for the sector.
The above chart shows the rally in VPU from the $96.09 low in March 2020 to a high of $160.51 in August 2022, a 67% gain. Reaching above the $166 level on Aug. 22, VPU was not far below the recent peak.
VPU is a highly liquid ETF, with over $6.3 billion in assets under management. It trades an average of 267,834 shares daily and has a low expense ratio of 0.10%. At the $166 level, the blended dividend yield was at the 2.57% level. VPU’s top holdings include:
Charts courtesy of Barchart
Utility Profits Growth
Inflation and recession are contradictions for utility stocks, but in 2022, the environment continues to support rising share prices, with attractive dividends for investors in the utility sector. Three reasons make utility stocks and VPU compelling on any price weakness over the coming weeks and months.
First, energy prices have risen to the highest level in years. While crude oil has pulled back from over $130 per barrel in March to the $90 level, natural gas was flirting with the $10 per MMBtu level on the nearby NYMEX futures contract on Aug. 22. The elevated oil and gas prices will likely continue to increase utilities’ profit margins over the coming months and years.
Second, higher energy prices are a supply-side economic issue created by the war in Ukraine, sanctions on Russia and Russian retaliation. The Fed’s monetary policy has little impact on energy prices in the current environment.