The high-yielding utilities sector is surging this year, and some say the best is still ahead
Is a good defense the best offense? The "defensive" utilities sector has beaten the market this year, and hit an all-time high Tuesday.
The impressive performance led Evercore ISI technician Rich Ross to comment Tuesday on CNBC's "Power Lunch" that "regardless of what you think about the world or interest rates, in isolation the charts of the utilities are a buy."
On a chart of the utilities-tracking ETF XLU (NYSE Arca: XLU), Ross points out that the sector has broken out of a "12-month base of support" with XLU forming a "bull flag" over the last few months, a pattern that normally precedes another rally. According to Ross, these short-term technicals are pointing to potentially $60 for utilities, a 12 percent rally from Tuesday's levels.
But he also points out that he sees another indicator that utilities are headed for more record highs. Not only has the XLU held a "150-week moving average now for almost seven years," but a rise in bond yields hasn't tempered the rally.
"You're at a new all-time high on the utilities, but the yields are not back down near their lows of 1.30 percent," the technician said. "So yes, clearly [utilities] are a proxy for interest rates, but whether those interest rates have been rising or just moving sideways, utilities continue to move forward. [That is] a bullish divergence that tells me you want to be a buyer here of this breakout."
Like many high-yielding stocks and sectors, utilities do tend to enjoy a close relationship with interest rates. The XLU has a dividend yield of more than 3 percent, which is significantly above that of the S&P 500 (INDEX: .SPX) and of the U.S. 10-year Treasury note (U.S.: US10Y). Stocks with high yields often rise when interest rates fall, since the lower yields in the bond market can make holding high-dividend stocks a more attractive prospect.
Susquehanna's Stacey Gilbert, however, doesn't necessarily believe that the sector is a buy. The head of derivatives strategy said that since the sector's valuation is "rich," she would not "love adding more money to it."
Gilbert did, however, suggest a way to play the sector.
"One of the areas that I do think is interesting that I really like that investors are implementing is looking at the individual names and overwriting, selling upside calls against long holdings," she said. "[That enhances] some of that yield more rather than recognizing levels where they think the stocks have gotten ahead of themselves. I think that's the right way to play the sector now."
For a trader who owns a stock and sells a call option, upside is capped, but in return for that, the trader receives extra yield as well as a bit of protection to the downside.
The S&P 500 utilities sector is now up 9.6 percent year to date, while the S&P 500 has risen by 7.8 percent.
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