A Bold, Bearish Call On Utilities ETFs

With the Utilities SPDR (ETF) XLU, the largest utilities exchange traded fund, up nearly 15 percent year-to-date, finding utilities bears is not the easiest of endeavors.

That scenario could start to change as the Federal Reserve nears its first interest rate increase of 2016, perhaps as soon as this month.

Still, XLU has recovered the losses experienced after Federal Open Market Committee (FOMC) meeting minutes out last month revealed a June rate hike is a possibility. XLU is actually up almost 1.1 percent over the past month and closed Thursday less 1.2 percent below its all-time high.

No utilities ETFs made all-time highs Thursday, but three dividend ETFs with heavy allocations to the sector did, indicating plenty of income investors still want exposure to the sector. Some analysts do not agree with that notion.

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In a recent research note, AltaVista Research tagged XLU with an Underweight rating, one of several sector SPDR ETFs the firm has that view on.

"Typically, funds in this category consist of stocks trading at relatively expensive valuations and/or having below-average fundamentals," said AltaVista.

That assessment goes against a couple of trends. For example, XLU and the Vanguard Utilities ETF VPU added about $150 million in new assets in May. Year-to-date, XLU has added $1.65 billion in new capital, one of the best totals among all sector ETFs.

Second, the calendar currently favors utilities ETFs. Starting in June, XLU is one of the two best-performing sector SPDR ETFs, on a historical basis, in three of the next four months (it is one of the two worst in July).

"Environmental regulations and distributed generation represent dual threats to profitability-- witness the declining trend in Return on Equity in the last few years, which may appear small but are forecast to result in only 1% annual earnings growth between 2011-16E. Meanwhile the recent rebound in share prices has returned the P/E ratio near its highs of the past five years, and pushing the sector down into UNDERWEIGHT territory," said AltaVista.

Based on estimated 2016 price-to-earnings ratio of 17.7, XLU trades in-line with the S&P 500 and in the middle of the pack among the sector SPDR ETFs as five of those funds are expected to have higher multiples this year, according to AltaVista data.