Issues

Is inflation really quelled? How fast will the Federal Reserve cut interest rates? And which campaign promises will the incoming Trump Administration push hardest to deliver?

The answers will literally make or break the S&P 500 in 2025. It’s one-third weighted in just 7 Big Tech stocks, already priced for perfection. And more stock market money is now passively invested than actively managed. So an S&P plunge would crunch many Americans’ wealth, and possibly the economy as well.

In the past month, America has elected a new president and Congress, along with literally hundreds of state legislators and governors. And the Federal Reserve has delivered on a second cut since its historic September 18 pivot, from “higher for longer” interest rates.

For investors, the far more consequential event has been the mostly passed season for Q3 earnings releases and guidance updates.

The Utility Report Card has my company-by-company analysis for the 170 utilities and essential services providers I’ve tracked now for nearly four decades. My top takeaway: Investment is booming, and that’s very good news for Conrad’s Utility Investor recommendations’ earnings, dividends and ultimately stock prices over the next few years.

On September 18, the Federal Reserve cut the benchmark Fed Funds rate by 50 basis points, to a range of 4.75 to 5 percent. The long awaited pivot from “higher for longer” interest rates ignited an investment media frenzy. But since then, the Dow Jones Utility Average is up less than 1.5 percent, barely matching the S&P 500.

That’s hardly surprising. From mid-April when rate cut talk started heating up until the Fed finally acted, the DJUA soared nearly 30 percent. So utility stocks were already pricing in the initial shift.

Not every big utility stock hit a 52-week high in the past month. But with the Dow Jones Utility Average up nearly 20 percent year to date, a baker’s dozen Portfolio stocks sell for more than their highest recommended entry points. That’s a massive turnaround from earlier this year. Consistent, strong earnings have been one factor: 26 Utility Report Card companies raised guidance after releasing Q2 results.

And only one of the 8 that cut was actually a regulated utility, weather-impacted gas distribution utility Spire Inc (NYSE: SR). The health and growth of underlying businesses always drives long-term investor returns. As the Portfolio discussion highlights, Conrad’s Utility Investor recommendations are on the right track.

The nascent trends I highlighted in the July 17 Alert “About that Volatility” have picked up steam since. That includes the likelihood of a Federal Reserve rate cut, as economic growth tapers and inflation moderates. Utilities and Big Tech stocks have noticeably traded places in the past month. The Dow Jones Utility Average is now ahead by 17.6 percent year-to-date, outpacing the suddenly weakening S&P 500 at 13 percent and the Nasdaq 100’s 10 percent. I’ve said for a while that interest rates were the key to utility stock prices short-term. And for at least the past few weeks, the trend has been our friend. But I see two key reasons to be cautious.

After an up and down month, the Dow Jones Utility Average’s year-to-date return is now just 5 percent. That’s still a percentage point better than the Dow Jones’ Select Dividend Index. But utilities are now well behind the Nasdaq 100’s 21.7 percent and the S&P 500 at 17.5 percent. Interest rates remain the key driver of utility stock returns. And with money market funds yielding north of 5 percent and the Federal Reserve still not pivoting to lower rates, price momentum is against us.

Utility mergers and acquisitions are heating up again. But utility stocks’ spring momentum has at least temporarily cooled. The Dow Jones Utility Average is still up solidly with a 6.3 percent year-to-date return, much better than most dividend paying sectors. But utilities are again lagging returns of 13.3 percent for the Nasdaq 100 and 12.8 percent for the S&P 500. The reason for the reversal: Yet another shift in investor expectations for Federal Reserve policy. And the consensus now is we’ll see few if any rate cuts this year.

There are no energy stocks in the S&P 500’s top 10. The biggest utility, NextEra Energy (NYSE: NEE), is only #56. And even all utilities and oil and gas stocks together are just 6 percent of the stock market’s premier blue chip index. That’s historic underweighting. But since oil prices bottomed in spring 2020, the S&P Energy Index has beaten the technology-stock laden S&P 500 by nearly 160 percentage points.

The Dow Jones Utility Average closed out Q1 barely in the black and lagging the S&P 500 by about 9.3 percentage points. The average total return for CUI portfolio stocks was a bit better at 5.8 percent. But the bottom line is this is still a stock market chasing momentum and growth stories, rather than value and dividends. The essential services stocks that have shone the most so far in 2024 have been tightly connected to popular investment themes like nuclear power, such as our top performer Vistra Energy (NYSE: VST), or else beneficiaries of M&A. MDU Resources’ (NYSE: MDU) pending spinoff of Everus Construction Group in late 2024, for example, is exciting investors as much as last year’s of materials company Knife River (NYSE: KNF) did not—mainly because KNF has roughly doubled in value since.

So far in 2024, the Dow Jones Utility Average lags the S&P 500 by nearly 10 percentage points. But over the past month, buying interest has picked up for at least a handful of CUI portfolio companies. Leading the way are nuclear powered Constellation Energy (NYSE: CEG) and Vistra Energy (NYSE: VST), with year-to-date gains of 46 and 57 percent respectively. But even underperforming Avangrid Inc (NYSE: AGR) now has a double-digit 2024 return, as parent Iberdrola SA (Spain: IBE, OTC: IBDRY) has made a non-binding all-cash takeover offer that’s likely to go higher. I continue to believe utilities as a sector won’t really capture upside momentum until there’s a genuine Federal Reserve pivot to lower interest rates. And with the central bank reactive as ever to the latest data point, investors have no choice but to be patient.