Enjoying the Run-Up, But Preparing for the Cooldown

The Dow Jones Utility Average hit an all-time high this month, raising the bar of expectations to levels that will be difficult to meet, let alone beat. Investors may be in for a bit of déjà vu: The sector last reached these lofty heights in summer 2016, at which point the Dow Jones Utility Average suffered a roughly 15 percent pullback.

This correction propelled our position in ProShares UltraShort Utilities (NYSE: SDP)—an exchange-traded fund that’s designed to deliver 2 times the Dow Jones US Utilities Index’s inverse daily return—to a roughly 25 percent profit.

Over the past year, these gains have evaporated with the sector’s run-up. But with the Dow Jones Utility Average trading at historically unsustainable valuations, we’re comfortable holding a hedge position that will thrive when the sector inevitably reverts to the mean.

Will utility stocks suffer a pullback this summer? The answer depends, to a large extent, on the direction of the US stock market, which has climbed higher while shrugging off political turmoil and middling economic growth.

Most of the companies covered in our Utility Report Card will report second-quarter results in late July and early August, creating the potential for company-specific sell-offs.

The Federal Reserve’s monetary policy could also give investors an excuse to take profits; however flawed, the conventional wisdom holds that rising interest rates represent a headwind for utility stocks and other dividend-paying equities.

Of course, the market can always remain irrational for months—or even years.

Although many of our Portfolio holdings trade above our buy targets (a high-quality problem), the market isn’t bereft of opportunities—this issue highlights some of our favorite investment ideas.

That said, investors may want to consider taking a partial profit off the table in some of their highest flyers. Better buying opportunities will come again.