Utilities Don't Give Us Much
We set out this month to find pockets of strength in the utility sector. Unfortunately, there weren't any.
The S&P 1500 Utility Sector Index has delivered a negative total return of 6.4% so far his year — only the beleaguered energy and materials sectors have performed worse. This negative return comes despite a recent bounce in the sector. Since July 24, the Utility Sector Index has gained 2.9%, tops among the 10 sectors.
Utilities' disappointing recent performance makes sense for at least two reasons:
1) Likely interest-rate hikes. With short-term interest rates held near 0% for more than six years, dividend-paying stocks have looked unusually attractive relative to many fixed-income securities. However, after months of signaling, the Federal Reserve seems ready to start boosting the federal funds rate later this year. We won't try to predict how fast the Fed raises rates, and history suggests utilities don't always lag during periods of rising rates (see the June 1 issue for more on this topic). However, the perception that rising rates hurt dividend stocks has likely weighed on utilities.
2) Weak operating momentum. Over the last year, the 74 stocks in our Utility Update averaged flat sales and per-share-profit growth of 5%. Blame part of the sales weakness on natural-gas companies, which face tough comparisons from quarters with rough winters in late 2013 and early 2014. In the last quarter, utilities averaged a 2% gain in profits while sales fell 5%, with only water utilities averaging higher revenue. The picture should improve next year, with the average utility expected to deliver 6% profit growth, in line with the average for the last five calendar years. Five of the six groups are projected to average more than 5%.
It can be tough to find winners in the utility sector, where many stocks look similar. But our Top 15 portfolio, which has returned 132.2% since the start of 2007 versus 71.6% for the sector index, has consistently outperformed. See the story below for more on the Top 15 Utilities portfolio or visit www.DowTheory.com/Go/Top15.
Top 15 has strong history
So far this year, our Top 15 Utilities portfolio has delivered a negative return of 5.5%, slightly better than its benchmark, the S&P 1500 Utility Index. While our portfolio lagged marginally last year (just 0.3% below the benchmark), it beat in the previous six calendar years, outperforming by an average of 5.9%.
We're pretty happy with six straight years of outperformance, and since the portfolio's introduction at the start of 2007, it has returned 132.2%, dwarfing the benchmark's 71.6%.
In our quest for superior returns, we've constructed a nontraditional portfolio that includes two master limited partnerships (MLPs), one a pipeline company and the other a distributor of heating oil and propane.