With the overall market enjoying a bit of a rally as inflation eases and the Federal Reserve indicating a less hawkish stance, the New Year could be a prime time to jump back into utilities.
Utility stocks have had a bad year, but investors are starting to ease back into the embattled sector.
Back in August, utilities were the absolute worst-performing sector in the S&P 500, while Information Technology (IT) stole the show:
In September, we saw NextEra tank horrendously to three-year lows. What happened to spook investors was that its subsidiary, NextEra Energy Partners (NYSE: NEP), significantly cut its annual dividend growth outlook to 5% to 8% through at least 2026, down from 12% to 15% in its earlier targets.
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But by the end of November, we saw the tech sector stutter.
Falling Treasury yields seem to pit utilities and tech against each other, moving in tandem in opposite directions. Utilities play a defensive role in the market, as opposed to a growth (offensive) position such as tech.
Safe-haven stocks such as utilities were damaged in the summer and early fall because of higher rates. These are safe-haven stocks because they are public services that tend to offer two key things to long-term investors: reliable dividends and lower volatility. If you see utility stocks spiking, you can generally expect the market to become more volatile. In other words, sudden movement into utilities stocks can indicate that short-term wider market volatility is coming; or, that the sentiment is such, as investors run here for safety.
There is no such surge right now. Investors aren’t flocking to the safety of utilities, but things are evening out from the pummeling this sector took earlier this year.
Inflation, The Fed, and Treasury Yields
On November 3, the U.S. Federal Reserve opted not to hike interest rates, leaving them unchanged at the range of 5.25-5.5%. Higher interest rates end up creating higher yields, which attracts investment capital looking for higher returns on bonds and interest-rate products. What utility stocks will really benefit from is the cutting of interest rates, and while that has not yet happened, it could, as the Fed signals a less hawkish stance. "The data is trending in the direction that the Fed wants to see," Pavlik said. "A 25- to 50 basis-point cut before the end of the summer 2024 would make sense as the economy slows down, for the Fed to fine tune how their policy tools are working,” Robert Pavlik, senior portfolio manager at Dakota Wealth Management, told Reuters earlier in November.
For more conservative investors, higher interest rates render bonds a better buy than utilities, so their money starts changing hands when the Fed is extra hawkish. And, of course, the reverse is also true. We saw this happen in 2008 when interest rates went down to almost nothing and conservative investors poured into utilities. While bonds have been rallying like nobody’s business of late, the sentiment is that the party is going to come to an end very quickly, which would mean more gains for utilities.
And at this inflection point, utilities are cheap, presenting a possible buying opportunity for investors before interest rates are cut.
Hedge funds seem to agree, based on the number of funds in a particular stock right now.
Oklahoma-based ONE Gas Inc (NYSE:OGS) has 16 hedge fund holders betting on better days, despite poor Q3 2023 earnings results, which saw a 7% dive in total revenue year-on-year. But the stock is now in the bargain-basement arena, trading at $59.19 on Friday, up nearly 2.7% on the day as utilities inch out of the doldrums.
Likewise, New Jersey Resources Corporation (NYSE:NJR) has 18 hedge fund holders, without missing a dividends beat, yet is trading down nearly 13% year-to-date, but has been edging up in recent days, gaining 1.35% on Thursday.
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Altus Power Inc (NYSE:AMPS), with 18 hedge fund holders, was up 2.80% on Thursday, but down over 17% year-to-date, suggesting some nice upside.
What about NextEra? Well, it’s clawing its way back. Year-to-date, NextEra (NYSE:NEE) is down over 29%, but on Thursday it was gaining 1.35%, and over the past five days, it’s up 3.15%. With a 3.2% dividend yield, despite the battering, this still looks like a unique growth stock.
The same is true for Black Hills Corporation (NYSE:BKH), which has also lost 30% year-to-date, but is starting to show signs of a turnaround. Known as the “dividend king” of utility stocks, at 4.8%, Black Hills now looks pretty cheap, though there is some caution in order as it lowers capital spending, which could hamper growth.
By Alex Kimani for Oilprice.com
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