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Utilities Sector Rating: Marketperform

Utilities sector overview

Falling interest rates, a shift in market leadership and concerns that we may be at a near-term peak in economic growth have led to better performance for the utilities sector. We continue to hold the group at marketperform.

Market outlook for the utilities sector

The utilities sector continues to be a bit volatile, performing better when growth and trade concerns resurface and interest rates fall, and underperforming when those concerns fade. We don’t believe at this time that the times of outperformance are sustainable, and are concerned that valuation levels for the group are above historical levels, according to data compiled by Yardeni Research. As a result, we aren’t yet upgrading the group, but due to growing growth concerns and trade tensions, we are suggesting that investors use times when the utilities sector is suffering, usually when the overall market is rising, to gradually add to utilities positions, especially if you are underweight the group at this point. While we still warn against using high-yielding equities as a replacement for fixed income, the dividend yield can be attractive in this low-yield environment.

We think U.S. economic data will continue to show growth, but the rate of growth appears to be slowing, as evidenced by the lower gross domestic product (GDP) growth projections by the Atlanta and New York Federal Reserve banks. This could make the traditionally defensive utilities sector more attractive. Inflation readings have perked up, but remain contained for now, with the Core Consumer Price Index posting a modest 2.2% year-over-year rise in July. This could entice investors into the higher-yielding utilities sector.

There are some additional positives for the sector, as some of the fundamentals in the utilities sector have perked up. BCA Research recently reported that electricity production was rising.

We aren’t overly bullish on the utilities sector, and it still seems unlikely to be a substantial outperformer in our minds, but we believe the elevated trade tensions and deterioration in global growth warrants some gradual adding to utilities positions, and making sure a portfolio is at least marketweight.

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 electricity production is growing again.
  • Attractive dividends: Dividend-paying stocks could 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 dividend-paying 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.

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Important Disclosures

Schwab Sector Views do not represent a personalized recommendation of a particular investment strategy to you. You should not buy or sell an investment without first considering whether it is appropriate for you and your portfolio. Additionally, you should review and consider any recent market news. Supporting documentation for any claims or statistical information is available upon request.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The Consumer Price Index (CPI) is an index that measures the weighted average of prices of a basket of consumer goods and services, weighted according to their importance.

The Citi Economic Surprise Indices measure data surprises relative to market expectations. A positive reading means that the data releases have been stronger than expected and a negative reading means that the data releases have been worse than expected.

The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. (MSCI) and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by Charles Schwab & Co., Inc.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.


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