Don't look now, but those boring old utility stocks have screamed higher since the start of 2016. Yep, that's right—the old "widows and orphans" stocks that traditionally offer investors stability, a side of defense, and a reliable dividend yield, churned out a 10.5% gain through March 11. Early-year broad market volatility saw jittery investors dive into utilities along with those looking to score solid dividend yields.
The utilities sector, which includes the likes of electric companies, gas companies, and water utilities, is known for its defensive nature. Investors nervous about the prospects for economic recession turned toward utilities this year, explains Sam Stovall, managing director at S&P Global Market Intelligence.
"Utilities, telecommunications, and consumer staples are considered defensive sectors because demand for their products and services remains relatively static. People are still going to eat, smoke, drink, light and heat their homes, and call their friends on the phone to complain in good times and bad," Stovall says.
The utilities sector is showing the second highest S&P 500 sector gain this year, behind telecommunication services, which boasted an impressive 12.4% gain through March 11, according to data from Standard & Poor's. That compares to a 1.1% decline in the S&P 500.
The Hunt for Yield
Another factor propelling investors into the utilities sector is simply a chase for yield. "If you look at these utility stocks, many companies offer attractive dividends of 3.5% or higher," says JJ Kinahan, chief market strategist at TD Ameritrade. Some of the larger names in this sector include Duke Energy Corp. (DUK), Exelon Corp. (EXC), Southern Co. (SO), and Dominion Resources (D). "All these stocks pay a very attractive dividend yield," Kinahan says.
Investors no longer expect the Federal Reserve to hike rates four times in 2016, which could keep investors focused on higher-yielding stocks this year. "There is no real big pressure on 10-year yields to go higher. Even for the July Fed meeting, the probabilities are only showing 50-50 for a rate hike," Kinahan says.
Since the Federal Reserve raised interest rates on December 16, the S&P 500 plunged 12% in a corrective pullback before rebounding smartly to levels about 5% under its all-time high reached in May 2015. The volatility has seen "higher-yielding stocks outperform more cyclical stocks," Stovall says. From December 15, 2015 (the day before the Fed rate hike) through March 11, the greatest returns were seen in the high-yielding groups: telecom services (+15.8%), utilities (+15.1%), and consumer staples (+5.2%), while the more cyclical sectors declined: tech (-2.3%), health care (-3.9%), and financials (-5.8%), Stovall says.
Utilities offer investors a defensive place to park cash in uncertain and volatile market environments. But, looking ahead, Stovall warns that the recent rush to utilities has triggered concerns about overvaluation. "Utilities are trading at a 10% premium to their long-term average price/earnings ratio," Stovall says.
Nevertheless, Stovall adds: "If recession is still a possibility, investors will continue to focus on defensive sectors. And at the same time, the Fed probably won't be raising rates aggressively should the economy slow."
For the short-term trading crowd, Kinahan suggests keeping an eye on the crude oil market. "Many of the utility sector stocks are highly correlated to crude oil, and we should see some resistance at the $40-per-barrel area," he says.
How to Scan for Stocks with High Yields
Looking for stocks with high dividend yields? TD Ameritrade clients can use the Stock Hacker scan in the thinkorswim® platform to screen for stocks with high dividend yields, as shown in figure 1.