Utilities provide essential public services, including water, gas, and electricity. Addressing climate change means changing methods of generating power to reduce carbon emissions.
Meanwhile, utility stocks have a long history as stable investments because the demand for critical services is recession-proof. Most utilities are government-regulated, with contractually guaranteed rates, making earning less volatile. Utility stocks tend to pay higher dividends than other stocks, making them defensive investments during economic downturns.
Markets are uncertain, with the U.S. election only days away. The Fed has cut short-term interest rates, but longer-term rates have not declined commensurately. Time will tell if the U.S. central bank’s plans to reduce the Fed Funds Rate by another 50 basis points before the end of this year and 100 basis points in 2025 will weigh on longer-term rates.
Meanwhile, falling rates will reduce utilities’ expenses and make the shares attractive compared to fixed-income products. Given the uncertain path of the U.S. economy, utilities could be a safe harbor for capital over the coming months.
Utilities are interest-rate-sensitive stocks
- In September, the U.S. Federal Reserve cut the Fed Funds Rate by 50 basis points, shifting to a more accommodative monetary policy path.
- The Fed signaled the short-term rate will decline another 50 basis points by the end of 2024 and will move another 100 points lower in 2025.
- Most utilities are government-regulated or have contractually guaranteed rates, making them less volatile than other stocks. Stable revenues allow utilities to pay attractive dividends.
- Utilities require substantial infrastructure and carry significant debt on their balance sheets, making them highly sensitive to interest rate changes. Falling rates lower their debt servicing requirements.
Utilities are cash machines for investors
- Historically, utility stocks are stable investments, paying higher dividends than other equity sectors.
- The XLU ETF’s blended yield is over double that of the SPY, reflecting the most diversified U.S. stock market index, the S&P 500.
- Moreover, the long-term chart shows a bullish trend of higher lows and higher highs, making XLU an ETF that pays an attractive dividend and delivers substantial capital growth.
The XLU ETF owns shares in the leading U.S. utilities
- The XLU ETF includes the components of the Utilities Select Sector Index.
- The XLU’s top holdings reflect a diversified group of the leading utility stocks.
- The top holding, with nearly 13.65% exposure, is NextEra Energy (NEE).
- The XLU has net assets of over $18.6 billion. More than 10.5 million shares change hands daily, and the ETF charges a nominal 0.10% management fee.
XLU’s dividend yield compared to the leading indices
- At $81.20 per share, XLU pays shareholders a 72% dividend.
- At $580.96 per share, the blended yield on the SPY ETF is 21%.
- At $423.49 per share, the blended yield on the DIA ETF is 67%.
- At $496.11 per share, the blended yield on the tech-heavy QQQ ETF is 61%.
- At $221.80 per share, the blended yield on the small-cap IWM is 16%.
The reasons to include XLU or utilities in portfolios
- Markets reflect the economic and geopolitical landscapes.
- The VIX, which reflects the implied volatility on S&P 500 stocks and is a “fear index,” has risen to around 20.
- The uncertainty of the November 5 U.S. election, wars in Ukraine and the Middle East, the bifurcation of the world’s nuclear powers, and rising U.S. debt levels could derail the stock market.
- Falling U.S. interest rates make stocks with higher dividend yields more attractive.
The many factors that can cause significant stock market volatility are a clear and present danger for investors and traders in the current environment. Utilities can be a safe harbor during stormy financial seas, and the XLU is a diversified ETF product with a history of stability and yield. The XLU’s trend remains higher, and the dividend yield is far more attractive than the leading U.S. equity indices.
Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!