Utilities (XLU) are an asset-heavy business, so they carry huge debt. Last year, the utility sector underperformed mainly because of a fear of interest rates heading higher. Higher interest rates increase utilities’ interest expenses, ultimately hampering their profitability.
According to top hedge fund manager Marc Lasry, the Fed will move ahead with interest rates very slowly. He expects an approximately 50 basis point hike in fiscal 2016.
Correlation with interest rates
The chart above depicts the negative correlation of utilities with the ten-year Treasury yield. The correlation coefficient stands at -0.75, which indicates that a further rise in interest rates may worry utilities and its investors.
Last year, conservative investors switched from utilities to Treasuries due to attractive yields. Interestingly, yields on ten-year bonds hovered near 2% last year while utilities yielded near 4%. Utility stocks were so weak last year that their yields rose sharply. Utility giants like Duke Energy (DUK), Southern Company (SO), and Exelon Corporation’s (EXC) dividend yields are near 4.7%, but none of the stocks were able to generate positive total returns.
Lasry says no need to panic
Lasry, giving his verdict on the US economy (SPY), said, “There is not going to be a recessionary environment in the United States. The fact is that whether it is growing at 1 or 2 percent.”
He also thinks China’s (GXC) slowdown isn’t as big a concern as some people have suggested. He reaffirmed that funds will again flow back to the safer United States from the emerging markets. He thinks markets will mostly be driven by an energy turnaround in the near future.