Fed Turned The Lights For Utilities ETFs

For as much as financial services exchange traded funds want the Federal Reserve to raise interest rates, utilities want the Fed to continue its near zero interest rate policy for as long as possible.

The reasoning is simple. Few sectors are as rate-sensitive as utilities. Recent showings by the Utilities Select Sector SPDR XLU and the iShares U.S. Utilities ETF IDU confirm as much as do historical data that underscore the vulnerability of utilities stocks in rising rate environments.

"Telecom was the worst or second worst performing sector in terms of average cumulative returns in 6 out of the 12 months following Fed liftoff,” said Bank of America in a note out earlier this month. The bank added “utilities were lackluster throughout the 12 months after Fed liftoff.” 

In other words, it is easy to figure out why IDU is up nearly three percent over the past week: Because the Fed did not increase interest rates. That does not mean the central bank will not do so next month, in December or sometime in the first half of 2016. However, some market strategists see utilities as a sound near-term bet.

“We would revisit more rate-sensitive parts of the market, such as U.S. utilities. Were interest rates rising, one would expect these "bond market proxy" segments to suffer. However, with long-term rates clearly stuck, utilities look less vulnerable, particularly as this sector has dramatically underperformed the rest of the market this year. At these levels, we would bring exposure back up toward a market weight,” said BlackRock Global Chief Investment Strategist Russ Koesterich in a note out Monday.

The benefit for investors willing to consider an ETF like IDU at current levels. First, there is the yield. IDU's trailing 12-month dividend yield of 3.53 percent is more than 130 basis points above where 10-year Treasury yields closed Monday. Second, investors will not be forced to pay a premium valuation for utilities' low volatility and robust yields.

Utilities stocks are inexpensive relative to the S&P 500, a rarity for the ultra-defensive sector that usually forces investors to pay-up for the luxury of that defensive posture. XLU's estimated 2015 price-to-earnings ratio is 15.5 compared to 16.7 for the S&P 500, according to AltaVista.

IDU, which is home to 60 stocks, has a three-year standard deviation of 14 percent and a beta against the S&P 500 of just 0.29, according to iShares data. Beta measures a security's relationship with the market as a whole, meaning a stock or ETF with a beta of one essentially moves in lockstep with the broad market.