Utilities Look Ready To Light Up
Summary
- Shunned by tech-enamored investors this year, this relatively staid sector could be a safe haven in an overdue market correction.
- Utilities stocks have had a challenging 2023 following solid outperformance last year.
- Through August 18, the sector posted a total return of -9% versus a surprising 15% rally in the S&P 500, led by several tech titans.
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By Ronald B. Silvestri
Shunned by tech-enamored investors this year, this relatively staid sector could be a safe haven in an overdue market correction.
Utilities stocks have had a challenging 2023 following solid outperformance last year. Through August 18, the sector posted a total return of -9% versus a surprising 15% rally in the S&P 500, led by several tech titans.1
Contrary to consensus, we think the market underappreciates the sector’s solid electrification and clean-energy growth fundamentals and long-term prospects.
The utilities sector includes suppliers of electricity, gas and water - companies that tend to outperform when investors run for safety. While that familiar story bore out in 2022, utilities fell out of favor as stunning advances in artificial intelligence (AI) sent investors piling into Big Tech, while some other sectors advanced as well.
Defensive sector rotations can happen just as fast: For example, when the tech sector suddenly shed 17% in the fourth quarter of 2018, utilities offered a safe haven by edging up about 1%.2 Timing these market transitions with precision can be challenging, but we think investors can take steps to get ahead of them.
Our case for utilities starts with a compelling relative valuation. Also, the year-to-date 2,400-basis-point disparity between utilities and the broader market has been surpassed only twice in the last 45 years - during the Three Mile Island crisis (1980) and the dot-com bubble (1999).3
And while the sector’s average 3.7% dividend yield trails the 4.2% offered by 10-year Treasuries, we think utilities have the potential to deliver attractive earnings-per-share and dividend growth in the 5 to 8% range.4
We also believe the sector’s circle of opportunity continues to widen with the broader societal shift toward electrification and clean energy.
For example, DTE Energy’s (DTE) CEO, Jerry Norcia, recently estimated that electric vehicle manufacturing facilities use roughly three times as much power as traditional auto manufacturing plants.5
The AI revolution will need more power, too: AI data centers are several times more energy-intensive in our view than traditional data centers.
Government support will also be important: Since the passage of the U.S. Inflation Reduction Act last August, the utility-scale clean power sector has announced $150 billion in funding, 46 new manufacturing facilities and nearly 20,000 new jobs, according to the American Clean Power Association.
We believe this combination of organic demand and supportive policy bodes well for the utilities sector, especially in a potential economic downturn. Patience may be required, but in the event the frothy stock market reverse course or cool off, we think utilities will be ready to light up.
Source: (1) FactSet; (2) FactSet; (3) Wolfe Research; (4) FactSet; (5) Wells Fargo
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