Shares of slow-growing utilities are experiencing a power surge, but is it one that could be abruptly turned off?
Utilities shares are soaring 20% as a sector so far this year. That's a high-voltage move, especially for a normally boring group in a tough year for stocks. In fact, utilities are beating the S&P 500 by the biggest margin on record, according to Bespoke Investment Group stats going back to 1941.
So why are investors piling into utilities like ConEd (ED) and Xcel Energy (XEL)? Because these stocks pay fat dividends and are super sensitive to interest rates. That makes them gold in today's world of unbelievably low and even subzero rates.
Utilities have even become a substitute for bonds, especially by those who think bonds have become far too expensive and are in the midst of a giant bubble.
"Utilities are notorious for being slow growers, but they've become all the rage due to investors' unquenched thirst for yield," said Mark Luschini, chief investment strategist at Janney Capital.
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But some think this game is getting out of hand and could end badly if the suspected bond bubble finally bursts. It's easy to see how utilities could be the first stock-market victim if rates suddenly rip higher at the first sign of stronger growth, inflation or an interest rate hike by the Federal Reserve.
Just look at how utilities like Dominion Resources (D) and Edison International (EIX) barely budged on Friday even as the rest of the stock market rallied around the shockingly strong June jobs report. That's because the positive economic news caused bond yields to rise a bit.
Even fans of utilities admit they look very expensive. The sector is trading at nearly 19 times forward earnings, according to S&P Capital IQ. That's well above historical averages and the richest multiple for utilities in at least a decade, according to Yardeni Research.
"The rush into these zero-growth stocks in search for yield has reached a fever pitch," Bespoke wrote in a recent report. The firm warned utilities have "extended well into extreme overbought territory."
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So does that mean utilities are in a bubble? Perhaps. Or at a minimum that the risk/reward makes it hard to justify jumping in now.
Michael Block, chief strategist at Rhino Trading Partners, argues that utilities look "bubbly," but he says that trend can continue given how ridiculously low government bond yields have fallen. He pointed to how Spain, a country with high debt and slow growth, can now borrow money for 10 years at the unbelievably low rate of 1.1%.
But extremely low rates can't last forever, right? Recall how rates spiked in the spring of 2013 during the so-called taper tantrum set off by fears over the Fed dialing back its stimulus program. When that happened, dividend-plays like utilities got crushed even more than the rest of the market.
That episode could repeat itself if Friday's jobs report is the start of a string of stronger economic reports that give the Fed confidence to resume its plans to raise interest rates.
"It's a trade we'll stay long in, but admittedly we he have our fingers close to the keystroke to sell in the event we sense a turn," said Janney's Luschini.
