Breakout

Don’t waste your energy on this defensive sector: Kotok

Jeff Macke
Breakout

No matter what the Federal Reserve does in terms of tapering Quantitative Easing on the margin, there’s little to suggest a hike of underlying interest rates is in the offing anytime in the foreseeable future. There may be some bumps along the way for the overall market, but as Cumberland Advisor’s Chairman David Kotok sees it the trend remains the long-term investor’s friend when it comes to equities.

Related: Fed pulls trigger on tapering, will trim bond buying by $10B a month

As investors who’ve been playing defense with utility stocks for the last 5 years know, getting a few extra points worth of dividend yield has been a disaster for relative performance. Kotok thinks yield trap will continue to be the enemy of capital gains in 2014.  In the attached video he provides three good reasons why:

1.  The mere threat of rising bond yields weighs on the sector

In the market perception is reality. With no organic growth to speak of in the utility sector, investors will be quick to flee if they think there’s a possibility that a safer source of competitive yields is on the way.

2. Regulatory pressures are a constant threat

Nothing is more politically popular than beating up utility companies with the audacity to seek higher profits. If you’re looking for some light reading there are any number of places to read about the ins and outs of anti-free market price manipulation in utilities. That’s not necessarily a bad thing, but it does explicitly limit profit potential.

3.  The companies don’t benefit directly from favorable moves in natural gas or oil prices.

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This confluence of factors has made the last 5 years much less lucrative for defensive investors. “People who sacrificed growth to get an extra point or two of yield gave up 60 or 70 points over the last 4 or 5 years in relative performance,” Kotok concludes, “there’s no reason to think that relative performance is going to improve in 2014.”

With the Fed having begun its long awaited taper, rates are on the move higher. If the utilities and Utility Select Sector SPDR (XLU) can’t start to close the performance gap relative to the SPDR S&P 500 (SPY), 2014 could be setting up as yet another slow slog for utility investors.

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