US Utilities Face Contradicting Economic Conditions

US Utilities Face Contradicting Economic Conditions

Utility companies provide essential services critical to sustaining life and comfort by supplying people with natural gas, electricity, water, and power. Investors tend to hold utility shares in portfolios as long-term investments because they offer price stability and attractive dividend income.

Common utilities include water, sewer, electric, gas, trash, and recycling companies. Some technology companies, including cable TV, internet, security, and phone communications, are often included in the utility sector. Many investors follow a long-term buy-and-hold strategy with utility stocks as they offer attractive dividends and capital gains, the best of both worlds.

Over the past months, rising interest rates, a strong US dollar, and uncertainty surrounding the geopolitical landscape have weighed on the overall stock market. Many market participants consider utilities a safe and stable investment choice during periods where turmoil causes increased price variance. However, utilities face competing influences in the current environment. With inflation rising to the highest level in over four decades, utilities face rising costs, which weigh on performance. Meanwhile, rising recession risks tend to make utilities an attractive investment sector. In September 2022, utilities face both inflationary and recessionary pressures, which can cause elevated share price volatility.

In 2021, the Fed and US administration called inflation a “transitory” and pandemic-related event. The monetary policy path in 2022 is an admission the Fed discounted the impact of rising prices. In 2022, they are doing the same, characterizing rising recessionary pressures as an economic “transition.” Time will tell if they are making another miscalculation. Meanwhile, the current landscape is confusing for those holding utility stocks in portfolios.

Inflation does not favor utility investments

• Utility stocks tend to offer stability and yield.
• Inflation increases expenses for utility companies.
• Rising interest rates compete with utilities and weigh on earnings.

Utilities are a safe harbor during a recession

• Economic contraction can lead to rate cuts to stabilize financial conditions.
• Utility dividends become more attractive during economic turndowns.
• Investors tend to flock to utilities during recessions.

Stagflation presents unique challenges for utilities

• Rising prices and economic contraction create a stagflationary environment.
• CPI and PPI over the past months have led the Fed to increase interest rates.
• Two consecutive quarterly GDP declines are a recessionary sign.
• Fed rate hikes may stem demand-side inflation but increase the potential for a deepening recession.
• The central bank has chosen to battle inflation at the expense of an economic downturn.

The Fed aims to make utilities more attractive

• The Fed remains on a hawkish monetary policy path.
• The September 20-21 FOMC meeting will cause the Fed Funds Rate to rise by 50 to 75 basis points.
• Fueling a recession could create a bullish environment for utility stocks.

Supply-side economic issues could keep inflation high

• The war in Ukraine continues to threaten rising food and energy prices, stoking inflationary pressures.
• Central banks can influence demand-side economic problems, but they have no tools to address the supply side.
• Geopolitics creates trade and other supply-side economic issues.
• Rising stagflation is above the Fed’s pay grade.
• Markets reflect the economic and geopolitical landscapes.

Expect volatility in the utility sector as it faces unique pressures in the current environment.

Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!