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By Caroline Valetkevitch
NEW YORK (Reuters) – Investors looking for ways to protect themselves from a possible market downturn and rising inflation have warmed utility companies, sometimes viewed as substitutes for bonds, as attractive alternatives.
The S&P 500 Utilities Index outperformed the broader market this month, up 9.3% to date, compared to the benchmark index’s 4.3% gain and the leading gains among sectors in March.
Driving profits could be a defensive move by investors to position themselves against a possible decline in stocks, with concerns about higher inflation mounting, as shown by the surge in 10-year government bond yields and expensive stock valuations, some say Strategists.
Utilities tend to do better in a downturn because they pay dividends and offer stability.
“It’s a bit of a defensive positioning,” said Joseph Quinlan, director of CIO marketing strategy for Merrill and Bank of America (NYSE 🙂 Private Bank in New York.
“We have some customers who want to be more defensive but want to stay in the market.”
While the economy is expected to recover strongly from the effects of the coronavirus this year, that optimism could be dampened until next year if unemployment remains high and growth slows more than expected.
Some investors say utility utilities may also benefit from hopes that the Biden administration will give a bigger push toward green energy. President Joe Biden is slated to unveil a multi-billion dollar plan to rebuild American infrastructure next week that may also tackle climate change.
“If the rhetoric of decarbonization accelerates, it will be good for utilities,” said Shane Hurst, chief executive officer and portfolio manager, ClearBridge Investments.
However, whether the recent surge in utilities leaves any room for maneuver is debatable, and many strategists and investors, including Quinlan, continue to favor cyclicals that benefit from economic growth over defensive groups like utilities.
The gains in utilities are due to a rotation of technology and other growth stocks into so-called value stocks. That fell in March after four consecutive months of profits.
Cyclicals, which investors dumped at the start of the pandemic, benefited the most from the rotation. A realignment of investment portfolios by institutional investors at the end of the quarter could add to the recent rotation from growth to value.
While utilities are still far behind annual earnings compared to many cyclical sectors, including energy, they are also viewed as inexpensive by some investors at this point.
After a poor performance in 2020, utilities “are really, really cheap right now,” Hurst said. “And this is an attractive place to be when you are in a market that is very profitable.”
The utilities sector is trading at 18.3 times the forward profit, compared to a value for money of 22.1 for the technology and 26 for the technology, according to Refinitiv.
David Bianco, chief investment officer for DWS in America, who has an overweight rating on utilities, said interest rates are still low but utilities are providing inflation protection because they may raise their prices.
On Friday, the S&P 500 utilities sector had a dividend yield of 3.3%, the second highest among the S&P sectors after consumer staples, and was well above the 1.5% return according to data from S&P Dow Jones Indices for the S & P 500.
The benchmark’s 10-year note yields stood at 1.660% on Friday, after hitting a one-year high of 1.754% the week before.
“Utilities are our preferred substitute for bonds,” said Bianco.