Learn Why Traders Love Utilities ETFs

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Includes: BUI, FUGAX, FUTY, FXU, GUT, IDU, RYU, SDP, UPW, UTG, VPU, XLU
by: Tom Lydon

Summary

Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities exchange traded fund, is up nearly 14% year-to-date.

XLU yields 3.8%, compared with 2.2% for the S&P.

Some investors see opportunity with rate-sensitive assets such as XLU and real estate ETFs.

By Jonathan Jones and Tom Lydon

The Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities exchange traded fund, is up nearly 14% year-to-date, by far the best performance among the sector SPDR ETFs, and more upside could be coming for utilities stocks and ETFs, reports ETF Trends.

Utilities sector fundamentals remain strong. However, utilities have been underforming due to the sector's inverse relationship to rising interest rates - when rates rise or investors fear higher rates, utilities typically underpeform, and vice versa.

Most investors view utilities as a reliable, income-generating asset that exhibit some bond-like characteristics. As interest rates declined, the sector appealed to many income investors for its relatively higher yields.

ETFs like XLU got a boost this week when the Federal Reserve opted to not raise interest rates. Further buoying interest rate-sensitive sectors such as utilities is the notion that the Fed will only be able to raise rates twice this year.

"Big utility stocks trade at an average of 17 to 18 times projected 2016 earnings, which isn't cheap considering annual industry earnings growth is generally in the low- to mid-single-digit range. The sector now trades at a premium to the S&P 500, which fetches about 16 times estimated 2016 operating earnings. The utilities ETF (TICKER: ) yields 3.8%, compared with 2.2% for the S&P," according to Barron's.

Some investors see opportunity with rate-sensitive assets such as XLU and real estate ETFs, noting that 10-year yields are overbought and sentiment against the likes of XLU is at bearish extremes, which could create opportunity from the long side with the utilities sector.

Looking at XLU's chart "you can see that the horizontal trendline near $45 has acted as a very influential level of support and resistance over the past 1.5 years. The breakout (shown by the blue circle) and the subsequent retest of the trendline and its 50-day moving average are technical signals that suggest that the bulls are in control of the momentum and that prices could be headed higher. Most active traders will likely look to enter a position as close to the trendline as possible to maximize the risk/reward of the trade. From a risk management perspective, technical traders will likely set their stop-loss orders below the horizontal trendline or the 200-day moving average ($43.23) depending on risk tolerance," according to Investopedia.

Defensive sectors, such as consumer staples, telecom and utilities, often trade at multiples that are richer than the broader market. That is the price to pay to play defense.

Utilities Select Sector SPDR

Click to enlarge

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.