An Appropriate Time To Embrace a Defensive Sector

Wednesday brought a sea of red for U.S. equity markets. The standout was the utilities sector. While the S&P 500's 2018 gains evaporated, the Utilities Select Sector SPDR XLU jumped 2.43 percent on volume that was well above the daily average.

This month, XLU, the largest utilities exchange traded fund by assets, is up 6.48 percent. Some analysts believe it's time to embrace the sector.

What Happened

CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth said his firm upgraded its rating on the utilities sector to Overweight from Marketweight. CFRA also downgraded the industrial sector to Marketweight from Overweight.

“Sam Stovall, Chief Investment Strategist at CFRA, explained that a very warm summer in the heavily-populated northeast, Mid-Atlantic and East North Central census regions will likely help the utilities sector’s EPS growth after a nearly normal summer last year,” Rosenbluth said in Wednesday's note.

This week and next week, over 92 percent of the Utilities Select Sector Index, XLU's underlying index, reports third-quarter earnings.

Why It's Important

The utilities sector's favorable dividend and low volatility traits could lure investors at a time of elevated equity market volatility.

“The S&P 500 utilities sector index dividend yield is 3.4%, significantly higher than the 2.0% yield for the S&P 500,” said Rosenbluth. “Christopher Muir, an equity analyst at CFRA, expects utility dividends to grow slightly faster than EPS as some companies continue to increase their dividend payout ratios. Muir also thinks the sector’s next twelve months P/E of 17.7X provides room for P/E expansion in an improving economy.”

The $7.63 billion XLU is home to 29 stocks with a weighted average market capitalization of $35.51 billion, according to issuer data.

What's Next

Among the 19 utilities stocks CFRA has Strong Buy or Buy ratings on, several are top 10 holdings in XLU, including NextEra Energy Inc. NEE and Duke Energy Corp. DUK. CFRA has an Overweight rating on XLU.

“XLU charges a modest 0.13% expense ratio and trades more than 21 million shares daily, with a penny bid/ask spread,” said Rosenbluth.

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