Issues

Not since 1987 have utility stocks failed to follow up a positive January with full year gains.

To a large extent, January’s move can be chalked up to a mood swing. A month ago, the emerging consensus was utility stocks were poor investments, doomed to suffer from rising interest rates, falling sales due to solar adoption and ultimately a revolt of regulators and customers.

The sudden retreat of emerging markets and their currencies has now taken that narrative off the front page. Rather, utilities are touted as a “hedge” against a repeat of the global market meltdown of 1997-98.

The investment media love a great story told from 30,000 feet. And it’s true that utility stocks were big winners during that crisis, even as the rest of the market cracked.

Current market action, however, is still nothing close to another 1997-98. In fact, there are already some signs of recovery from the recent damage, including the apparently stabilizing Australian dollar. As a result, by this time next month, investors are just as likely to be mesmerized by an altogether different “big story.”

That’s why I’m far more impressed by the strong fourth-quarter results posted by the utilities in my coverage universe..

Where January leads, the rest of the year follows: That Wall Street adage has generally held up for most stocks over the years.

But it definitely has not for utilities—they’ve received a false signal 10 times in the past 30 years.

The keys to 2014 are ensuring the health and growth of the stocks you own, and buying selected bargains. These appear when investors let emotions get the better of them, or follow strategies based on false premises.

The most deadly conventional wisdom last year is still very much in play now: Selling utilities and other dividend-paying stocks for fear of rising interest rates.

As it turned out, rates did rise a lot in 2013, with the 10-year US Treasury note yield soaring more than 70 percent. But the Dow Jones Utility Average, Alerian MLP Index and S&P Telecom Service Index all finished 2013 with double-digit total returns.

That’s exactly what they did in 2009, the last time the 10-year Treasury note yield rose by better than 70 percent. In fact, the trio’s worst year by far since 1984 was 2008, a year of sharply falling interest rates.

Barring a real financial earthquake, this will be the ninth year of rising interest rates since 1992.

2013 will also be the eighth of those nine that utilities and other dividend paying stocks finished in the black. The only exception was 1994, when deregulation fears upended electricity and communications.

Utilities also rose eight years when rates fell. All their biggest declines, however, were during years of falling interest rates, particularly 2008.

Utility stock prices ultimately reflect the health of underlying companies. Stocks of financially healthy companies with growing dividends always move higher. But when an economic calamity brings interest rates lower quickly, they can drop in a hurry.

It’s been barely two weeks since Washington avoided the first federal government default, at least since the Articles of Confederation were in force. The autumn rally in stocks, however, actually began during the heat of the crisis.

The trigger was long overdue recognition the Federal Reserve isn’t going to abandon loose money until the economy is strong enough to handle it. All the “taper” talk that clogged the airwaves for months proved to be meaningless blather.

That’s hardly the first time conventional wisdom has proven disastrously wrong for the investors who bet on it.

The silver lining is resulting volatility was a solid opportunity to buy good stocks cheap. And thanks to that, we’ve already seen sizeable gains for the Conrad’s Utility Investor Model Portfolios, though they’ve only been around three months.

Utility stocks have posted fourth-quarter gains 36 times since 1969. But last year the Dow Jones Utility Average dropped almost 4 percent, virtually all of it during the first two weeks of November.

As we enter the fourth quarter of 2013, a number of trends and developments have investors flashing back to the final three months of last year.

The government is again in budget disarray and the deadline for default is fast approaching. The US economy is still plodding, with second quarter GDP growth of 2.5 percent. The gap between rich and poor nations in the eurozone continues to grow. And softer Asian growth is still shaking up global natural-resource markets.

But there are differences from last year.

For one thing, the stocks are cheaper. Despite what’s shaping up as a solid year for business, conventional wisdom since late April has held that dividend-paying stocks are bond substitutes—and that a change in Federal Reserve policy to “tapering” is about to drive them off a cliff.

My feature article presents more evidence that the bearish thesis about utilities' sensitivity to interest rates is more sensationalism than sense. But the more important question is, what if great companies sold off enough to make them bargains again?

The weight of evidence in this month’s Utility Report Card indicates that real bargains have emerged, three of which I am adding to my Conservative Income Portfolio. 

August was a down month for utilities and other essential services companies—likewise the broad stock market. That continues a trend beginning in late April, when fears first stirred of an end to Federal Reserve easing.

Since then, the Fed has not changed policy. But the markets have acted as though much higher interest rates are a done deal. The yield on the benchmark 10-year Treasury Note yield has nearly doubled. And expectations are we’ll see it at 4 to 5 percent, as the precursor to a dramatic, across the board rise in rates.

This inaugural issue continues my almost three decades of covering essential-services stocks, with a few changes I think you’ll find useful.

My approach, as always, is to focus on companies which pay safe, growing dividends that will build our wealth over time. Names that provide essential services--electricity, heating, communications, water and pipeline capacity--enjoy stable demand and generate reliable cash flow, regardless of economic conditions or Wall Street’s latest investment fad.

More than 100 years after these industries came into being, they’re more critical than ever to a functioning society. Usage can rise and fall from quarter to quarter, or even year to year. But as the global economy grows, so do these businesses--and the benefits accrue to shareholders in the form of rising dividends and capital appreciation.

No merger between regulated utilities has ever failed to produce a stronger, more viable entity. Nor has any regulated utility ever vanished, save through consolidation. Even the owner of Three Mile Island--the former Metropolitan Edison--was able to come back from the 1978 accident. And investors who bought at the bottom realized a 35-to-1 return on their money over the subsequent decade.

No other industry can make these claims. That’s not to suggest that regulated utilities haven’t suffered severe setbacks at times; however, given the nature of the assets that these companies own, stocks and bonds issued by essential-service providers usually recover from whatever disaster befalls them.