Utilities stock has experienced an incredible rally through 2024. It is now one of Wall Street’s most discussed trades for the year.
Some financial experts warn that valuations are soaring, and the economic indicators have changed. This suggests that this surge may be too rapid.
FactSet data shows that the Utilities Select Sector SPDR ETF, which tracks this sector, is down nearly 2.5% since its high on October 2nd of $81.47 a share.
Even though the ETF has declined, it is still up 24,4% for the year, which exceeds the S&P 500 gain of 21.4%.
If the ETF ends the year at a level above the current one, this would be the best performance of the utilities sector in more than two decades.
Some experts think a correction is imminent as the interest rate climbs and investors’ sentiment changes.
Utility stocks are at risk of falling as interest rates rise
The changing interest rate outlook in the US is one of the main factors behind the recent declines in utilities.
Investor confidence has increased following a series of positive economic indicators, as have fears about inflation.
The higher yields on Treasury bonds have negatively affected utilities, historically seen as defensive and interest-rate sensitive plays.
George Cipolloni is a portfolio manager with Penn Mutual Asset Management. He says that the steep drop in interest rate earlier this year has been a major factor behind the rally of the financial sector.
As yields reverse, utilities lose some of this momentum. Cipolloni highlighted in a MarketWatch article how yields on bonds inversely impact stock prices.
What percentage of utility gains can we attribute the change in interest rates? It’s a good amount, I believe.
A warning sign for stretched valuations?
Stretched valuations are another factor that has contributed to the decline in utility stocks.
Utility stocks were depressed in late 2023. However, the rally of 2024 has driven valuations to overvalued levels.
Travis Miller is an energy and utilities analyst at Morningstar. He noted that this sector does not offer the same bargain as it used to.
Miller, MarketWatch..COM
Vistra Corp. was cited by him as an example of the boom in utilities.
Stocks of independent power companies have soared over 200% in the past year. They even beat tech giants such as Nvidia.
Vistra is currently valued at more than 90x its profits over the last year. This raises concerns as to whether or not these gains will be sustainable.
Investor interest has been sparked by deals like Constellation Energy’s partnership with Microsoft for the restart of a nuclear plant at Pennsylvania’s Three Mile Island.
Miller warned that it could take many years for the full benefits to be realized, as the market might have underestimated their impact.
I think that stocks are up too fast, and too much excitement has been factored in.
Analysts see warning signs
Technical analysts are concerned about the chart of utilities stocks, but they do not limit themselves to fundamental issues.
Jonathan Krinsky is the chief technical strategist of BTIG. He warned that in a recent report, the XLU ETF was trading at the highest premium since 2003 to its 200 day moving average, a sign that a correction between 7% and 10% could be imminent.
Jason Goepfert is a Sentimentrader senior analyst. He also pointed out that utility stocks are prone to pullbacks when they rise too high above their 200 day moving average.
Utility companies, which are typically affected by such an environment and struggle to survive in it, could face more pressure as Treasury yields rise.
Long-term Investors should be cautiously optimistic
Analysts are not all gloomy about utilities. Nicholas Colas is the co-founder and CEO of DataTrek. He maintains an optimistic but cautious outlook.
He acknowledged that the utilities sector may not have the strongest performance over the coming 12 months. However, once the Federal Reserve’s interest rates continue to be cut, bond yields will start to fall again.
Colas added that “the utilities sector will continue to perform well once the bond yields fall,” adding that AI-driven utility demand may also be a future driver of gains.
Lori Calvasina of RBC Capital Markets’ US Equity Strategy shared a more moderate view. She noted a slower flow of money into funds that focus on utilities.
She said that investors no longer get the same return on their investments from utilities because the interest rate rush has passed.
Calvasina stated that utilities are not compelling anymore from a valuation perspective.
The post Utilities Stocks Hit Record Surge in 2024 but Analysts Warn of Possible Correction may be updated as new developments unfold.
