Heightened uncertainty about what Brexit means for the global economy has increased the attractiveness of traditional defensive utility stocks.
Shock waves are still reverberating through financial markets in the wake of the United Kingdom’s unexpected vote to leave the European Union. Markets don’t like surprises, and aftershocks are likely to keep investors on edge in the weeks ahead as European leaders sort out the next steps.
“Brexit has raised the level of political and economic uncertainty in Europe to the point that central banks throughout the world, including the [Federal Reserve], — are likely to be more accommodative and for longer than they would otherwise have been,” says Albert Brenner, director of asset allocation strategy at People’s United Wealth Management in Bridgeport, Connecticut. “Prospects for a Fed rate hike have been pushed out to year-end or into 2017. This even-lower-for-even-longer rate environment will drive more yield-seeking investors to utilities and support utility returns.”
Even before Brexit, the utilities sector was a big double-digit gainer in the first half of 2016.
[See: 11 Great Investing Tips for Women.]
Out of the 10 Standard & Poor’s 500 index sectors, utilities chalked up the second biggest gain at 16.4 percent through June 24, second only to the 17.8 percent rise in the telecommunications services sector. That compares to a 0.3 percent decline in the S&P 500 during that time, according to S&P Global Market Intelligence data.
The stellar performance in utilities in the first half of the year was all about defense, says Hilary Kramer, New York City-based editor of the GameChangers stock newsletter.
“Face it,” Kramer says. “The market as a whole still looks a little rich in the face of elusive overall growth and shocks overseas. Unless you can dig deep to find the right stocks, utilities are an attractive place to park.”
Utility stocks pack the double punch of potential for stock price appreciation, along with a reliable dividend income stream.
“Currently, the utility sector of the S&P 500 has a dividend yield of 3.29 percent — the second-highest after the telecomm sector, which yields 4.36 percent. Not surprisingly, the telecom sector is the only sector to have outperformed utilities year-to-date,” Brenner says.
“I love yield stocks, and utilities are a classic place to find them,” Kramer says. “Once you capture a rich dividend at a good price, it’s yours until you sell. You’re locking in that rate, possibly for life or more realistically until the fundamental landscape changes. Buying the right utility when you can find it at a discount is like buying a relatively high-coupon bond. In a world where bonds themselves pay extremely low interest, this is how you compensate.”
Utilities already show big gains this year, and investors may wonder if there is room for more upside. Chuck Self, chief investment officer of iSectors in Appleton, Wisconsin, says utilities are well-positioned to outperform other sectors in the second half of the year. Here’s why:
Limited currency exposure. U.S. utilities are a domestic play and have little exposure to the rising U.S. dollar, which will negatively impact most multinational companies, Self says. Also, “utilities’ growing dividend yields will continue to be attractive compared to declining interest rates,” he says.
Baby boomer demand. Self also points to larger demographic trends that support continued and long-term interest in income-paying utility stocks.
“As baby boomers shift into retirement, there will be increased demand for dividend growth, instruments and utility stocks will meet this demand,” Self says.
Good for portfolios. “Given our positive view on utilities over the next few years, investors will want to be exposed to the sector in their portfolios,” Self says. “Although every investor has different growth, income and risk profiles, the average investor can be comfortable holding a 10 percent to 15 percent position.”
[See: The 10 Best Materials ETFs We Could Dig Up.]
For long-term investors looking to add utility names to their portfolio, the Utilities SPDR (ticker: XLU) exchange-traded fund is a great place to start shifting a portion of your fixed-income exposure to dividend stocks, Kramer says.
“The yield is still around 3.3 percent, which is a lot better than what you’ll get in the Treasury market, and the ETF format means you can buy or sell any day and they’ll keep track of your dividend dates for you,” she says.
Kramer also points to two individual utility stocks that have eased off recent highs. For investors who don’t want to buy at recent highs, consider Public Service Enterprise Group (PEG), Kramer says.
“It has come down around 6 percent from its peak so there’s relative value there, and even at these levels it pays 3.7 percent,” she says.
National Grid (NGG) is a British gas provider. “Shares are obviously depressed because people dumped everything in London. But the Brexit pushed the yield to 4.7 percent. The risk here is that the pound will take a bite out of that dividend before it gets to you,” Kramer says.
“Still, if you’re feeling ambitious and think the pound has bottomed, this company’s not going away,” she says. “The important thing to remember is that when you want to accumulate, do it when the stocks are cheap so you can lock in the current yield for the long term.”
Self points to iShares US Utilities (IDU) as a vehicle investors can consider. The fund owns a broad range of utility stocks, including large, mid and small cap. It has the highest yield of the major utilities ETFs at over 4 percent, Self says.
[Read: How 7 Big-Box Retail Stocks Are Faring.]
“Also, it has the lowest portfolio turnover rate of the major utilities ETFs at 3 percent. This is important because low turnover rate reduces the capital gains that are taxed to the shareholders,” he says.
More from U.S. News
8 Soaring Stocks That Suffered the Big Bounce
11 Ways President Trump’s Tax Plan Could Affect Americans
How to Defend Your Portfolio With Utilities originally appeared on usnews.com
