Roger S. Conrad

The growing popularity of green bonds creates opportunities for savvy investors and can help utilities to reduce their cost of capital.

After bottoming shortly after the US presidential election, the Dow Jones Utility Average has gained more than 13 percent. This rally has propelled utility valuations to the frothy levels that prevailed last summer, just before the sector sold off in the second half of the year. Investors have plenty of reasons to be optimistic this spring. We expect a strong first-quarter earnings season and, as we pointed out in the November issue, US election results favored telecom sector’s big dogs as well as many gas, electric and water utilities. Utility stocks have also posted strong returns, despite the Federal Reserve’s efforts to normalize monetary policy. The Dow Jones Utility Average has generated a total return of more than 23 percent since the Fed first increased interest rates this cycle, outperforming the S&P 500 by almost 10 points. However, frothy valuations make it difficult for popular utility stocks to generate additional upside. NextEra Energy (NYSE: NEE), for example, appears to have run out of gas now that the stock is in the $130s. And the sub-2 percent yields paid by the highest flyers aren’t much compensation for sticking around in the hope that these stocks will defy the odds and climb higher. A pullback in the broader market remains the most likely catalyst for utility stocks to revert to the mean. High valuations across the board give investors plenty of reason to worry about how much longer this aging bull market can last.  

With first-quarter earnings season around the corner, we explain how investors can tune out the noise and focus on what really matters.

We sold Kinder Morgan’s common stock for a loss at the end of 2015 and rotated into the midstream company’s 9.75% Convertible Preferred Shares of 10/26/18 for their superior yield. This move has paid off with a superior total return.

With many utility stocks trading at frothy valuations, a big yield is hard to find.  

This former utility has transformed itself into an exploration and production company that's a pure play on the Permian Basin.

We assess E.On's third dividend cut since 2011 and explore other areas of potential risk.

We revisit our basket of fixed-income securities and take profits on one bond that has rallied hard since the presidential election. We also explore the fallout from Westinghouse's bankruptcy.

Shares of utilities and other essential-service companies have slipped from the highs hit earlier this month, reducing the number of Portfolio holdings that trade above our value-based buy targets to 14. Whether this wavering marks the start of another leg down for the Dow Jones Utility Average remains to be seen. However, the recent rally creates a high bar of expectations and increases the risk that investors will view any hiccup as an excuse to take profits. This month’s feature article highlights some of the macro catalysts that could send utility stocks lower. The current environment favors stock-picking over broad-based exposure, a point underscored by the widening discrepancy between the top and bottom performers in the utility sector. Although the Dow Jones Utility Average posted a total return of 18.2 percent last year, the index’s top performer beat the worst by 39 percentage points. This performance gap stands at 20 percentage points this year, despite the Dow Jones Utility Average gaining 5.4 percent. A retrenchment to normal valuations would widen this range. At this point, only 37 stocks tracked in our 205-company Utility Report Card trade below our buy targets. In fact, several dozen best-in-class names that earn A or B Quality Grades in our proprietary system trade at levels where investors should consider taking a partial profit off the table.  

With the Dow Jones Utility Average trading at historically elevated valuations once again, our focus shifts to the macro headwinds and tailwinds at play.