Utilities Sector Rating: Underperform

What is the utilities sector?

The utilities sector comprises electric, gas and water utilities; independent power producers and energy traders; and companies that generate and distribute electricity using renewable sources.

Utilities sector overview

An improving U.S. economy could create a headwind for the utilities sector, the potential for rising inflation could lead to higher interest rates, reducing the attractiveness of dividend-paying utilities companies.

Market outlook for the utilities sector

Utilities stocks have been a bit more volatile than usual as their performance appears to be more tied to interest rates than it has been historically.  Shares have rallied when bond yield have fallen and declined when yields have risen.  We have warned against using equity dividends as a proxy for bond yield income as the risk characteristics are much different. We believe investors are slowly heeding that advice and rotating out of the utilities sector, contributing to its underperformance to this point over the past year.

We think U.S. economic data will continue to show improvement, prompting investors to move into more cyclical areas of the market, away from the traditionally defensive utilities sector. Although recent inflation readings have been relatively weak, we believe a tight labor market and improving economy could lead to rising inflation and higher rates than the market is currently expecting, potentially resulting in investors moving out of the "yield-chasing" trade that has helped to bolster the sector, much as we’ve seen over the past year during times of rising rates.

Although it can be difficult to resist performance chasing at times, recent events have shown that can be treacherous, and we continue to believe a stronger economy and higher interest rates support a rating of underperform for the utilities sector.

Factors that may affect the utilities sector

Positive factors for the utilities sector include:

  • Improvement in housing: An improving housing market could lead to higher electricity demand in developing areas, and we’re seeing signs that may be occurring as housing starts have started to creep higher again.
     
  • Attractive dividends: Dividend-paying stocks remain attractive compared to relatively low yields on conservative fixed- income products. And should economic prospects decline, defensive, dividend-paying stocks could become even more attractive.

Negative factors for the utilities sector include:

  • High fixed costs: Capacity growth has been rising, which has been a sign of underperformance for the sector in the past.
     
  • Accelerating economic growth: This would likely make the defensive utilities sector less attractive. 
     
  • Rising interest rates: This would make the yield-heavy utilities sector less competitive with fixed income investments. Additionally, relatively high debt ratios in the sector could be problematic.

Clients can see our top-rated stocks in the utilities sector.

Want to learn more about a specific sector? Click on a link below for more information or visit Schwab Sector Views to see how they compare.

Schwab Sector Views

Consumer discretionary

Consumer staples

Energy

Financials

Health care

Industrials

Information technology

Materials

Real estate

Telecom

Utilities

 

Next Steps

Talk to Us
To discuss how this article might affect your investment decisions:
-          Call Schwab anytime at 877-338-0192.
-          Talk to a Schwab Financial Consultant at your local branch.

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Important Disclosures