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Utilities ETFs Can Burn Brighter

editor@etftrends.com (ETF Trends)

The Utilities Select Sector SPDR (XLU) and rivals, such as the Vanguard Utilities ETF (VPU) and the Fidelity MSCI Utilities Index ETF (FUTY) , are among this year’s top-performing sector exchange traded funds.

While impressive upside moves by XLU and friends have drawn plenty of cheers, there is no dearth of criticism and concern about soaring utilities ETFs. However, despite the best efforts of some market observers to talk investors out of stakes in the utilities sector, the group looks primed for additional upside.

Related: Utilities ETFs Keep Rising

Last Thursday, about 30 ETFs hit all-time highs. Underscoring the strength of the utilities group, seven of those ETFs were dedicated utilities while several more were dividend or low volatility ETFs with large weights to utilities stocks.

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Tortunes of the utilities sector seem to be tied to the Federal Reserve’s interest rate outlook. Once the Fed eventually hikes interest rates, the higher rates will make fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.

The Fed, though, may push off on an interest rate hike to July, especially after the unexpectedly weak jobs data. Nevertheless, investors should begin to consider the end game and the potential negative effects a rising rate environment can have on rate-sensitive equities like utilities.

“Performance-wise, the Utilities sector through 6/9/16 had outperformed all other S&P 500 GICS Level 1 groups Year-to-Date, with returns of 16.27%, swamping the S&P 500’s (SPX) 3.5% return. On a 12-month basis Utilities are leaders as well, thumping the next best sector (Consumer Staples), by over 600 bp, at 19.66%. Who would have thought this group could outperform when SPX lies within See It Market.

Related: Investors Pay up for Protection With Utilities ETFs

Given the utilities’ dividend association, the sector is also found in many dividend-focused ETF strategies. For instance, the iShares Select Dividend ETF (DVY) is the second largest dividend-related ETF on the market, with $15.2 billion in assets under management, and the ETF includes a hefty 31.7% tilt toward utilities.

DVY could see further upside because the Fed may not be able to raise interest rates as much as previously planned this year, which would keep pressure off utilities and consumer staples names.

“Many might be loathe to touch the Utilities sector given concerns about high valuation, or interest rate normalization just beginning, and some investors feel that yields on the long bond should go nowhere but higher. Yet precisely the opposite is happening, and at least technically, it looks like another few months of outperformance and above-average relative strength is likely out of this group,” adds See It Market.

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Utilities Select Sector SPDR


Tom Lydon’s clients own shares of DVY.