Utility stocks this year have mounted a rally unseen in more than two decades. In the third quarter, utilities are the best out of 11 sectors that comprise the S & P 500, climbing 18%. As a group, utilities are poised to score their largest quarterly gain since George W. Bush was president in 2003. Year-to-date gains are even more substantial, at around 27%. If that holds through yearend, utilities will see their biggest annual advance since 2000, when they surged more than 50%. “Utilities are the hottest sector in the market currently,” Wolfe Research Rob Ginsberg said in a note to clients in August. That hasn’t been the case in a generation. “When was the last time someone said that? It’s been a while.” XLU YTD mountain Utilities Select Sector SPDR, YTD The strong performance this year marks a turnaround for the power and light group. It finished both 2022 and 2023 in the red. There are a few reasons behind the unusual rally for the group. Utilities are seen as outsized beneficiaries of lower interest rates, thanks to their above-average capital requirements and lofty dividend yields. And the Federal Reserve just embarked on what’s likely to be a lengthy easing campaign. Plus, the group is also starting to get a look from growth investors looking to play the power generation needed for the great big artificial intelligence datacenter buildout. September highs The Utilities Select Sector SPDR Fund (XLU) , an ETF tracking utilities in the S & P 500, hit multiple all-time highs in September, underscoring the momentum. Indeed, Ginsberg noted traders in recent months have poured money into the sector , including stocks such as NextEra and PG & E . Bank of America’s head of U.S. equity strategy Savita Subramanian echoed that view earlier this month, upgrading utilities to overweight from market weight. She said the group was uniquely positioned to get a boost from an environment of lower interest rates. Part of Subramanian’s recommendation comes because of their above-average dividends. Generally, she expects quality income stocks to gain prominence in coming years, supplanting growth stocks that have dominated the market for the past 15 years or so. “Quality and income are the new growth and P/E expansion,” Subramanian wrote to clients, referring to stocks that investors have rewarded with higher price-to-earnings multiples. She noted that the total long-term return of the S & P 500 utilities sector â including the effect of reinvested dividends â was in line with the Nasdaq Composite ‘s, likening their performance to the tortoise and the hare children’s fable. XLU .IXIC 5Y mountain The utility ETF vs. the Nasdaq Composite, 5 years Part of the buy-in to utilities came as the Fed dropped rates, according to Bank of America data. In fact, Bank of America found investors pushed nearly $1.3 billion into utilities during the week of the central bank’s September policy meeting where it cut by half a point. That marked the sector’s largest inflow seen in the bank’s historical data, going back to 2008. To be sure, caution flags abound. Wells Fargo head of equity strategy Christopher Harvey downgraded utilities to neutral from overweight in mid-September, walking back the firm’s late 2023 upgrade. He said it’s no longer “a non-consensus oversold group” now that the sector has gained favor and the stocks rallied. Additionally, Harvey said that after the runup, utility stocks now reflect investors’ decision to avoid risk and pursue companies that stand to gain from softer interest rates. Looming pullback or limited gains Almost all the stocks in the sector are tracking for gains in the quarter. But for those that have seen the largest moves, Wall Street sees either a looming pullback or little room for further appreciation, reflecting how far some stocks have run. Take the best performer of the quarter: Vistra . The Texas-based electricity company’s shares have soared 39%, bringing its year-to-date gain above 200%. Now, the average analyst polled by LSEG sees the shares barely moving over the next 12 months, based on the consensus price target, even as the typical analyst continues to rate Vistra a buy. Vistra and Constellation Energy â up 29% in the quarter â have seen outsized gains on the back of enthusiasm for their nuclear power capacity and the outlook for electric sales to colossal data centers that are used to power artificial intelligence. Analysts don’t see Constellation moving much either over the next 12 months. At the other end of the spectrum, CenterPoint Energy of Houston is the only utility stock in the S & P 500 that’s fallen this quarter, down 6%. Analysts are less than enthusiastic about its prospects too. The typical analyst surveyed by LSEG has a hold rating and figures the stock might eke out a 2% gain over the next year.
Source Agencies
