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Market Pulls Back Again – Time for Utilities Stocks?

25 October 2012 in Trading Ideas

The recent performance of equities has been painful for many investors. Tuesday’s plunge pushed the market to a level 3.5% below where it was five weeks ago.

And perhaps even more anxiety-inducing is that the recent drop has brought the S&P 500 back to where it was in late March – that’s right, no capital appreciation in stocks for the past seven months.

While the market is still up more than 12% for the year, it’s this sort of grinding action that has many investors seeking better returns elsewhere. Much of this has been seen in the rotation by traders into bonds from stocks, with the theoretical assumption being that some sort of return on investment (in the form of the bond’s yield) is better than a stock going nowhere.

But in equities, too, the instinct to play defense seems to have moved to the forefront for many investors. With tech stocks underperforming (down more than 6% in the last month) and not offering much immediate promise of growing one’s portfolio, sectors that exhibit a little more stability in tough market times – and generate some income in the form of dividends – can begin to look attractive.

And so we consider utilities – not often the generator of “hot” stock tips, but a sector that was an outperformer the last time investors appeared to be down on stocks. In the past month, for example, the Utility Bills motif is down just 1.3%, while the S&P 500 has fallen 2%.

And consider this: during the late spring to midsummer of 2012 (roughly the four-month stretch from April through July), when the market was pulling back 5% from its highs, utility stocks, as measured by the Utilities Select Sector SPDR (XLU) exchange-traded fund, were up nearly 6%.

(The Utility Bills motif was constructed in late June).

Bullishness toward utilities stocks, which have traditionally been associated with above-average dividend yields, is easy to understand in the current market: With 10-year bond yields hovering around 1.8%, any stock paying a dividend yield of significantly more than that could offer some portfolio protection.

On the other hand, Larry Swedroe offers some caution in a recent piece for CBS Moneywatch. He cites a recent study of 85 years of stock market performance that shows utilities not only delivered a lower return but did so with more volatility.

And, Swedroe says, utilities generally have their worst years when the overall stock market is doing poorly. The sector lost 23% in 2002 and 29% in 2008.

In addition, a recent article on Seeking Alpha illuminates a point worth remembering: while utilities generally offer a higher-than-average yield, their dividend payments aren’t often increased. In fact, only a handful of the 15 stocks in the Dow Jones Utilities Index haven’t cut their dividends in the past two or three decades.

Following that line of reasoning, the upside of utilities should be qualified – and not seen as a fool-proof place to hide out during a broad downturn in stocks.

Performance data was as of 10/25/2012. Performance data and returns are based on past and are not representative of results an investor could expect to achieve. The 1-month and 3-month return shows how a particular benchmark motif could have performed over a stated period of time. Returns of individual motifs do not take into consideration certain fees and/or commissions, corporate actions, or other activity that can affect the return an investor could expect to incur. The performance results attempt to follow a standardized and consistent methodology for performance reporting. While we believe the performance data is gathered from reliable sources, the information that generates performance results uses historical data that we believe to accurate but has not been validated and may contain errors in pricing or other conditions. Reference to return of index does not imply its performance is comparable to a motif, but rather serves to provide a reference point.  For detailed information on how we calculate returns, please visit www.motifinvesting.com.

 
Tags: utilities