Investing Topics: Utility Stocks

Our bet against utility stocks has continued to pay off, while the selloff in the sector has pulled prices closer to our value-based buy targets. Stay disciplined.

While the market sorts out the implications of the 2016 federal election, the recent selloff in utility stocks and results at the state level create opportunities for savvy investors.

The Edison Electric Institute's annual financial conference takes place this week. Here's a quick preview of some of the themes we'll dig into at this year's event.

The upcoming gubernatorial elections could have important implications for utilities in these states.

While the market fixates on whether the Federal Reserve will hike rates, too many income-seeking investors ignore the danger lurking in their portfolios.

It's been an active year for mergers and acquisitions in the utility sector. We discuss our key takeaways from a major deal that closed ahead of schedule and highlight some of the main themes that will be in play going forward.

Utility stocks’ summer swoon picked up steam, with the Dow Jones Utilities Average down more than 9 percent from its high in early July. The financial infotainment industry has blamed this pullback on speculation that the Federal Reserve could raise interest rates this fall. In reality, the run-up in utility stocks to record valuations set the stage for momentum-seeking investors to use any excuse as an opportunity to take profits. Expect to hear a lot more about US monetary policy and its implications for utility stocks if this correction deepens in coming weeks. But bear in mind that weakness in the US economy likely will prevent the Federal Reserve from further tightening this year and that market history reveals scant correlation between utility stocks and the direction of interest rates. Consider that when the Federal Reserve hiked the benchmark interest rate by 425 basis points between June 2004 and June 2006, the Dow Jones Utilities Average generated a total return of more than 60 percent—almost four times the gain posted by the S&P 500. Concerns about rising interest rates may give investors an excuse to sell utility stocks in the near term, but frothy valuations not seen since the 1960s will be the real cause. At these levels, momentum-seeking investors tend to have itchy trigger fingers. Against this backdrop, we continue to err on the side of conservatism and bide our time for utility and telecom valuations to revert to the mean, at which point will look to deploy the dry powder we’ve accumulated by exiting riskier positions and taking partial profits on big winners.

The recent selloff in utility stocks has been a boon for our hedge position, but the sector still trades at historically elevated valuations. Investors should stick with our three-part game plan for navigating this challenging market.

A strong US dollar has weighed on the returns generated by international utility stocks in recent years. But investors should consider looking abroad for high-quality utility and telecom names that trade at reasonable valuations and offer a favorable risk-reward proposition.

The recent spate of equity issuance is yet another sign of frothy valuations in the utility sector, but these moves set the stage for future growth. Investors should bide their time and wait for a pullback to buy our favorite utility stocks.