For close to three years as U.S. stocks steadily moved higher, investors favored low-beta, defensive sectors such as consumer staples and health care. Utilities stocks and ETFs were part of that conversation and deservedly so. Over the past three years, the Utilities Select Sector SPDR (XLU) and the Vanguard Utilities ETF (VPU) are up 54.8% and 57.4%, respectively.
The utilities trade, already showing signs of vulnerability, was dealt another blow Tuesday when Exelon (EXC), already a dividend cutter this year, was downgraded “buy” to “hold” by Deutsche Bank. That sent the shares down almost 8% on volume that is already close to double the daily average. [A Utilities ETF For Yield And Defense]
Carnage for the utilities sector did not end there. First Energy (FE) is off 7.4% on volume that is already more than double the daily average after Credit Suisse downgraded the stock from “outperform” to “neutral.”
XLU is not down nearly as much, but the largest utilities ETF by assets, is lower by almost 1% and that loss comes after the fund had already slid 6% in the past month. Exelon and First Energy are both top-10 holdings in XLU, combing for almost 10% of the fund’s weight, according to State Street data.
VPU, the Vanguard offering, is holding up slightly better with a loss of 0.72% today, but that brings the ETF’s loss to over 6% in the past month. VPU, the utilities ETF with the lowest expense ratio at 0.14%, featured a 4.9% allocation to Exelon at the end of the first quarter, according to Vanguard data.
Ongoing weakness in utilities could be indicative of at least two scenarios. First, a cyclical rotation could be under way where investors are starting to favor higher beta sectors. Investors could be moving away from traditionally defensive sectors that have been bid up to overvalued levels. Cyclical sector ETFs for energy, technology and materials have been outperforming since mid-April. [Some Sector ETF Charts Pointing To Cyclical Rotation]
Second, valuations are viewed as frothy for slow-growing utilities. The S&P 500 Utilities Index had a P/E ratio of 15.9 at the end of April compared to 14.1 for the benchmark index itself, according to WisdomTree data.
XLU currently has a P/E of almost 16, indicating that investors will not only be paying up to grab yield and play some defense, but they will also be paying a premium for a sector ETF that has recently turned to laggard from leader.
As just one example of a sector ETF that underscores the returns/valuation conundrum now being offered by the likes of VPU and XLU, the Energy Select Sector SPDR (XLE) , a higher beta ETF to be sure, has a P/E of just 13.2 and has jumped 4.8% in the past month.
ETF Trends editorial team contributed to this piece.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.