Warning Signal: The Stretched Rubber Band of an Overlooked Stock-Market Sector and its Implications for the Economy

Investors have a golden opportunity in the utilities sector, which has been the worst-performing part of the U.S. stock market so far in 2023. However, recent data suggests that the sector’s fortunes may be turning around. The S&P 500 Utilities Sector has advanced over 3% in September and is currently the best-performing group in the S&P 500, surpassing even the energy sector. This comes as technology stocks, particularly information technology, have experienced a decline in value.

Utility stocks faced significant challenges earlier this year when higher interest rates made them less attractive compared to Treasury bills and money-market funds. Unlike rapidly growing technology stocks, utilities stocks are typically seen as dividend-income investments or defensive holdings during economic downturns. Utility companies, which provide electricity, water, and gas utilities, tend to offer stable dividends and experience less volatility compared to the overall stock market. This year, the utilities sector is expected to pay a dividend yield of 3.3%, more than double the S&P 500’s yield of 1.6%. However, it falls short of the yield of 10-year and 2-year Treasury bills.

Despite these challenges, investors could benefit from the utilities sector, which is currently undervalued compared to technology companies. The S&P 500 Utilities Sector is trading at 17.4 times its estimated earnings for the following 12 months, while the broader S&P 500 and the S&P 500 Information Technology Sector are trading at higher multiples. Market analysts also suggest that the recent uptick in utility stocks may indicate a broader shift towards “risk-off” trades and deeper anxiety about the U.S. economy.

Morgan Stanley strategists forecast that utility stocks will continue to perform well in the coming quarters due to several catalysts. These include regulatory decisions related to project approvals or settlement in electric-rate cases. For example, the PPL Corporation is seeking approval from the Kentucky Public Service Commission for its plan to replace aging coal generation with cleaner energy sources. Other catalysts include U.S. Treasury guidance on eligibility for the green hydrogen production tax credit and increasing demand for renewable energy systems.

Despite a challenging week for the stock market, with the S&P 500 and Nasdaq Composite experiencing losses, the utilities sector remains a promising investment opportunity. Investors should consider the undervalued nature of utility stocks and the potential for positive regulatory decisions and increased demand for renewable energy. As the economy continues to evolve and adjust to changing conditions, the utilities sector may offer stability and long-term growth potential for investors.

Original Story at www.morningstar.com – 2023-09-17 21:10:00