It’s darkest before they turn on the lights

31 January 2012 | By Vanessa Drucker

Against a flat overall market, humble power businesses returned 14.8%, even before hefty dividends in an abysmal rate environment. Arthur Hill’s chart for September 17 is worth 1,000 words: while every single other Standard & Poor’s (S&P) sector was below water, utilities peeked above the surface.

In 2012, utilities have fallen out of fashion. Bears insist the stocks have become overpriced, in terms of high PEG ratios which measure company PEs divided by growth rates. Yet the same drivers of yesteryear remain valid. If you are ready to give up on utilities, and throw in your lot with cyclicals, you must believe that (1) equity markets have definitively turned around and are poised for substantial gains, and (2) that interest rates will rise soon, to compete with dividends. 

But Ben Bernanke has assured us that the Fed will keep a lid on rates through 2014; equity markets look overbought after a massive move since October; and European headwinds persist. Add in steady revenue streams, low operational risk and consistent demand for power, with another overlooked bonus that American utilities also have little exposure to Europe.

A step back to 2008 reveals how the utilities and other S&P sectors fared, relative to the market. Glance at the relative curves of the 12 sectors depicted, and you will note that over the four-year period, utilities show the healthiest upward trend. That is unsurprising, considering their yields, which historically trade slightly beneath 10-year Treasuries, now offer a premium of over 200 basis points.

Technically, XLU’s longer-term trend from March 2009 remains bullish, in a rising wedge pattern, a shape with a mildly bearish bias that represents diminishing momentum on each successive high. The medium term from May 2010 still looks robust in a rising channel pattern, with support at 33.96 and resistance at 36.07. Why not allow the sector a short breather, but be ready to come back for those juicy dividends?

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