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Utility Stocks Continue to Outperform as Treasury Yields Slide

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Defensive stocks back in focus

On Wednesday, utility stocks continued to outperform as benchmark Treasury yields remained weak for the second consecutive day. On the day, the ten-year Treasury yield slid below 2%, falling close to its lowest level since November 2016.

The Utilities Select Sector SPDR ETF (XLU), which is representative of the top utility stocks, gained 0.7% on the day. Utility stocks and Treasury yields generally trade inversely.

XLU vs Treas

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On Monday, anxiety over the global economic slowdown intensified after the US threatened to impose additional tariffs on Eurozone goods. Treasury yields have been weak this year and have fallen more than 27% so far. Utilities at large have gained more than 15%, while broader markets are up ~20% year-to-date.

Top utility stocks kept climbing

Top utility stocks continued to trade close to their peaks. Renewables titan NextEra Energy (NEE) and top regulated utility Southern Company (SO) hit new 52-week highs on Wednesday, gaining 0.5% and 0.8%, respectively. Peer utility stocks American Electric Power (AEP) and Dominion Energy (D) rose ~1% each.

According to the CME FedWatch tool, traders are expecting a 100% likelihood of at least a quarter-point rate cut this month. Utilities are considered one of the most sensitive sectors to interest rates. However, utilities at large have returned 63% since the Fed started its rate normalization in December 2015. The S&P 500 has returned 57% in the same period. A potential interest rate cut could make utility stocks even more attractive. Lower interest rates would reduce debt-servicing costs and could improve utilities’ profitabilities. Utility stocks’ yields would also probably look more alluring than bonds.

Even though trade war tensions somewhat waned after President Trump and President Jinping agreed not to impose any new tariffs over the weekend, a concrete solution to the trade war could take a long time. Until then, volatility in the broader markets could be a big positive for defensives such as utilities.

The yield on the three-month Treasury bill was close to 2.20%, while the ten-year Treasury yield closed at 1.95% on Wednesday, indicating an inverted yield curve. Thus, there seem to be a variety of indicators implying that investors may take shelter in relatively safe assets amid growing broader market uncertainty.

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