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Utilities Sector Rating: Marketperform

By

Brad Sorensen

photo
CFA, Managing Director of Market & Sector Analysis, Schwab Center for Financial Research

Brad Sorensen heads market and sector analysis for the Schwab Center for Financial Research and writes for several Schwab publications. He is a member of Schwab's Investment Strategy Council.

Before joining Schwab in 2004, he was a senior analyst at AMG Guaranty Trust, where he designed portfolio strategies for high-net-worth individuals. Sorensen graduated from the University of Colorado with a bachelor's degree in finance and master's degrees in business administration and finance. He is a Chartered Financial Analyst charterholder.

October 11, 2018

Member for

1 year 8 months
Submitted by satya.billa on Thu, 10/11/2018 - 14:02
Utilities Sector

Utilities sector overview

A growing 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

A recent shift in market leadership and concerns that we may be at a near-term peak in growth has led to better performance for the utilities sector and we recently upgraded the group to marketperform.

Market outlook for the utilities sector

The utility sector has received a boost recently as investors moved into defensive sectors as concerns over global growth were exacerbated by the ramping up of trade rhetoric. We don’t believe this is the start of a prolonged market downturn but the shift in market leadership could last for several months as peak growth concerns are met with trade concerns and, while we still warn against using high-yielding equities as a replacement for fixed income, we recently upgraded the sector from underperform to marketperform.

We think U.S. economic data will continue to show growth, but the rate of improvement is slowing, as evidenced by the decline in the Citibank Economic Surprise Index, which could make the more defensive utilities sector more attractive. Inflation readings have perked up, but remain contained for now, which could entice investors into the higher-yielding sector, with the Consumer Price Index moving up to a still modest 2.9% year-over-year rise.

There are some additional positives for the sector as some of the fundamentals in the utilities sector have perked up, with BCA Research reporting that electricity production is rising, while their valuation indicator has corrected out of overvalued territory.

We haven’t all of a sudden gotten bullish on the utilities sector, and it still seems unlikely to be a substantial outperformer in our minds, but enough of the negatives we were looking at have dissipated in our view that an underperform rating is no longer appropriate, resulting in our upgrade to the group to marketperform.

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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