With an economic downturn emerging on the horizon, utilities are in a favorable market position relative to other sectors in the economy. Therefore, their recent outperformance should continue going forward.
…Out of the 11 major sectors in the U.S. economy, utilities have been the best performing sector by far over the last year…While segments like energy, materials, industrials, financials, and others are well off their highs, utilities are in a solid uptrend, trading around new all-time highs…
[Here’s a look at] the utilities sector’s performance vs. other segments in the economy over the past year:
- Utilities: up by 16.6%
- Real estate: up by 14.6%
- Healthcare: up by 8.3%
- Technology: up by 6.4%
- Consumer discretionary: up by 5.2%
- Consumer staples: up by 4.2%
- Communication: up by 2.3%
- Energy: down by 1.6%
- Industrials: down by 2.5%
- Materials: down by 5.2%
- Financials: down by 7.5%
Just looking at the above sector performance should give market participants pause over the likely future performance of the economy. We clearly have the most defensive sectors leading now, with some of the most cyclical segments (materials, industrials, financials, energy), in negative territory over the past year. This type of price action is indicative of a market that is in the very late stages of an economic cycle. When defensive names start to substantially outperform cyclical stocks, it indicates that market participants are selling stocks that are tethered to the wellbeing of the economy and are accumulating stocks that are likely to withstand a market downturn.
…Utility stocks [are in demand for a number of reasons, namely, they:]
- are great in times of an economic slowdown, as everyone needs electricity and water, and essentially no matter what happens in the economy most people will continue to pay for these basic utilities.
- are basically natural monopolies, implying that in many cases there are no direct competitors to provide these basic but crucial services. Thus, utilities are largely immune from softening sales, demand issues, price volatility, and competition
- [and] many utilities, in conjunction with their steady revenues and earnings streams, provide stable, sizeable, and often expanding dividends. Most of the quality utility names I’ve looked at and considered for my portfolio pay very safe and stable 3-4% annual dividends.
…[In an effort] to “recession proof” my portfolio…[I have been]:
- extending my gold related holdings,
- introducing a healthcare segment,
- and increasing positions in defensive dividend stocks.
Next, I want to add several high-quality utility stocks that should:
- further reduce volatility,
- increase yield,
- and add a supplementary layer of stability and safety to my portfolio.
Here are 3 utility plays I am considering for my portfolio:
1. AES Corporation (AES) generates and distributes electrical power across more than a dozen countries and
- has been shifting more towards solar and other sustainable solutions with its acquisition of sPower in 2017,
- has recently undergone a large-scale reorganization of its business aimed at trimming costs,
- has a market cap of around $12 billion,
- trades at only about 12.62 times next year’s consensus EPS estimates,
- and provides a dividend of around 3%.
AES is an extremely strong uptrend, and the stock is up by around 75% over the last year. Despite the likelihood for a short-term pullback in the shares, AES is likely to outperform the market longer term.
2. FirstEnergy Corp. (FE) services roughly 6 million customers throughout states like Ohio, Pennsylvania, West Virginia, and others and
- has a market cap of around $22 billion,
- trades at roughly 16 times next year’s consensus earnings estimates,
- and pays out a dividend of about 3.7%.
…The stock is…up by about 30% over the past year. Like with AES, while shares appear a bit overbought on a short-term technical basis, longer term, this stock is likely to outperform the market.
3. Utilities Select Sector SPDR ETF (XLU) is an ETF comprised of various U.S. utility companies…[with]
- 29 holdings…[of which] the top 10 making up 61% of the weight [with the top 5 holdings – NextEra Energy (NEE), Duke Energy (DUK), Dominion Energy (D), Southern Company (SO), and Exelon Corp. (EXC) – accounting for more than 40% of the ETF’s weight;
- a weighted average market cap…[of] about $39.6 billion;
- an average P/E ratio…[of] around 21;
- and a dividend of about 3%.
We see that XLU has been in a very strong uptrend over the last several years and this advance should continue going forward.
As the economy slows, market conditions should continue to push market participants towards the stability, safety, and yield utilities offer….[That being said,] while utilities should continue to outperform going forward, this may not be the most optimal time to step in. The utilities sector is quite overbought right now, both on a fundamental and on a technical basis…and a pullback is likely to occur soon. Investors should use the upcoming pullback as a buying opportunity…