Utilities Stocks Lead Market Higher, Signal Defensive Shift

The utility sector was the best performing slice of the S&P 500 Index pie in the first quarter of 2014.  The Utility Select Sector SPDR (XLU), which tracks 32 large-cap utility infrastructure companies, posted a gain of 10 percent through the first three months of the year.  The three largest holdings in this ETF include: Duke Energy Corporation (DUK), Dominion Resources (D), and NextEra Energy (NEE). 

This performance was largely attributable to stabilization in interest rates coupled with a shift in investor demand from high beta companies to a stalwart sector that is known for its defensive properties.  The gain in utility stocks comes on the heels of a relatively mediocre 2013 that saw this sector flat-line after the Fed indicated it would begin reducing its quantitative easing measures. 

One of the primary benefits of investing in utility companies is their above-average dividend yields and low stock price volatility.  Right now the current 30-day SEC yield on XLU is 3.65 percent, compared to 1.84 percent for the broad SPDR S&P 500 ETF (SPY).  In addition, utility stocks make up the bulk of the PowerShares S&P 500 Low Volatility Portfolio (SPLV) with a weighting of over 24 percent.  This sector is considered to be one of the most steadfast in terms of its base of established companies providing essential services to nearly every consumer in the country.

Another way to play the utility sector is to consider a more global approach in the form of the iShares S&P Global Utilities ETF (JXI).  This ETF invests in a broader subset of 70 utility companies around the world.  The top country weightings include: United States, United Kingdom, and France.  One of the benefits of this ETF is that you get exposure to both domestic and international holdings in a single diversified investment vehicle. 

Moving forward, utility stocks are likely going to be the beneficiaries of additional strength if we see further deterioration in small cap stocks, consumer discretionary names, and other high beta areas.  However, they are also susceptible to headwinds in the form of rising interest rates as the Fed begins to tighten monetary policy.  This tug of war should lend itself to further opportunities for tactical investors.