‘The rubber band is so stretched’: why this once-overlooked stock-market sector is sending a warning signal about the economy

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It hasn’t been a great year for investors to own stocks in the utilities sector – the worst-performing part of the U.S. stock market so far in 2023 – but...

It hasn’t been a great year for investors to own stocks in the utilities sector – the worst-performing part of the U.S. stock market so far in 2023 – but that could be coming to an end.

“Utilities are very oversold right now,” said David Wagner, portfolio manager at Aptus Capital Advisors. “It seems that given this oversold nature that the rubber band is so stretched so far in one direction that one ought to always be on guard for some type of abrupt flip to the script.” The utilities sector is expected to pay a dividend yield of 3.3% this year, more than twice the 1.6% of the S&P 500 SPX, but well below the 4.321% yield of the 10-year Treasury bill BX:TMUBMUSD10Y and the 5.03% yield of the 2-year Treasury note BX:TMUBMUSD02Y, according to FactSet data.

The S&P 500 Utilities Sector is trading at 17.4 times its estimated earnings for the following 12 months, while the broader S&P 500 is trading at 19.4 times its expected earnings and the S&P 500 Information Technology Sector is trading at 27.8 times its projected earnings for the same period, according to FactSet data.However, market analysts think “an abrupt snap-back” in utility stocks may also point to some “risk-off” trades or deeper anxiety about the U.S. economy.

Strategists at Morgan Stanley forecast the 10-year Treasury yield to retreat to 3.35% by the second quarter of 2024 in their base case. They said the market is vulnerable both to a slowdown in growth and cooling of inflation amid healthy growth — two outcomes that investors do not seem prepared for. Several stocks in the utilities sector “have meaningful regulatory decisions” coming this year related to project approvals or settlement in electric-rate cases, said Arcaro and his team, in a Thursday note.

 

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