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Three Months In, Utilities Are Lighting Up the Market

7 April 2014 in Trading Ideas

The first quarter of the year certainly rewarded investors who were keen on caution.

Gold, as it turned out, was the quarter’s best-performing asset class, rising 20%, despite pulling back over the past two weeks.

For stock investors, however, it was defensive names that delivered outperformance amid the S&P 500’s tepid three-month increase of 1.3%.

Utilities and health care stocks, which have typically offered perceived havens to investors looking to escape a volatile market, delivered the most profitability. Utilities stocks soared 9%, as investors, as a whole, are likely now beginning to doubt that stocks can repeat last year’s 30% runup.1

The Utility Bills motif has risen 3.6% in the past month. The S&P 500 has lost 1.7% in the same time frame. Over the past 12 months, the motif has increased 14.7%. The S&P 500 is up 20.5%.

 

As the Wall Street Journal recently pointed out, utility equities have also been helped in the early year by the pullback in bond yields. Last year, defensive sectors like utilities sold off as rising yields on bonds made even slightly riskier investments less attractive.2

However, as yields pulled back early this year to a range where they treaded for some time last fall, interest in utilities was revived, helped also by the market’s wider swings.

In addition, some investors expect decent profit growth out of utilities. The sharp increase in US production of natural gas, which is used as a heating fuel and to generate electricity, has led to declines in the price of the fuel. This has been a boon for utilities, which have been able to lock in historically low natural-gas prices years in advance, the Journal said.

Although natural-gas prices in cash and futures markets surged during the unusually cold weather across the country, some commodity traders and analysts expect prices to stay low by historical standards due to rising US gas production. While state regulators often limit how much utilities can charge, the companies were likely to see higher revenues because of increased demand from consumers this past winter, according to the Journal.

Naturally, this doesn’t mean the utilities sector is without potential obstacles that could hinder future performance. Many analysts continue to expect yields to increase, and it’s worth noting that the 10-year bond recently saw its yield climb back above its 200-day average.

Meanwhile, valuations could be increasingly tricky, the Journal said. Seven weeks ago, utilities in the S&P 500 were trading at about 15.4 times analysts’ forecasts for their next 12 months’ profits. That was 15% above the average price-to-earnings ratio for the sector since 1995.

What’s more, the P/E level is now even higher, as utilities tacked on another five percentage points of return into the quarter’s end.

On the other hand, if bond yields continue to remain in check, aligning with what might be one of the few sectors to post a double-digit-percentage gain this year may start to look even more attractive.

1Matt Krantz, “‘Defensive’ sectors give investors more than just safety in first quarter,” usatoday.com, April 1, 2014, http://marketsblog.usatoday.com/2014/04/01/investors-looking-for-cover-find-it-with-defensive-sectors/.

2Dan Strumpf and Matt Jarzemsky, “Investors Restore Power to the Utilities Sector,” WSJ.com, Feb. 12, 2014.

  1. Ron Nunemaker
    29 Jul at 4:33 pm

    This Motif “Utility Bills”appears to be designed from the outset as a “low risk” model based motif finely optimized using your proprietary “risk evaluation engine” – I assume some combination of Motif Index, valuation, beta and volatility would rank it for risk in comparison to other low risk motifs with high Index value that your team has designed using the same criteria -I have tried unsuccessfully to find that combination empirically – Can you provide some clue to how risk as you define it – is REPRESENTED BY THE CRITERIA YOU PROVIDE for your motifs [ Index, valuation, beta and volatility]
    It appears to me that virtually none of the customer written motifs have any similar computation of risk assessment overtly incorporated in their design – most appear to be completely naïve to measurement of risk [drawdown]

    Reply
  2. 4 Aug at 5:07 pm

    Ron –
    The Volatility measurement for a Motif represents the annualized standard deviation of daily returns on a portfolio holding the same share weights as the Motif, and is measured in a range from Low to High. Since the standard deviation of returns are commonly used as a measure of portfolio risk, a Volatility measurement that is High is indicative of the fact that holding the motif in the past subjected the holder to larger fluctuations or higher risk.

    The Valuation metric represents the present valuation of the stocks in the motif relative to the broader equity market. The Valuation metric is calculated as the composite Price-to-Earnings ratio for the stocks in the motif weighted by their respective share weights in a range from Low to High.

    Reply

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