Utility ETFs and Stocks - Should You Buy, Sell, or Hold Utilities?

Sam Subramanian PhD, MBA

Although the S&P 500 has advanced 32% since the March 9 market bottom, the rally has been quite selective from a sector perspective. Groups decimated during the recent bear market have rallied the most. Financial shares are up big after losing 81% from September 30, 2007.

With investors demonstrating healthy risk appetite, defensive sectors have generally lagged. Utilities Select Sector SPDR (XLU), for example, is up just 15%.

Things have been worse for shares of individual utility companies like Consolidated Edison (ED), FirstEnergy (FE), Southern Company (SO), and Wisconsin Energy (WEC). These stocks trade fairly close to their 52-week lows. At current prices ED, FE, and SO shares carry plump dividend yields nearing 6% or more. WEC's yield is lower at 3.7%.

Shares in the Utility sector have lagged the recovery. The Utilities Select Sector SPDR ETF (XLU) is up just 15% while the S&P 500 has advanced 32%.

So, why are Utilities out of favor?

Part of the reason is that the weak economy has quashed demand at most electric utilities. With the nation gripped in a recession, most state regulators are reluctant to grant healthy rate increases. Weak demand is offsetting benefits from lower fuel prices. As a result, reduction in 2009 earnings forecasts has been quite common among utilities.

Other reasons for underperformance include investors' preference for more volatile stocks during a period when the stock market has been buoyant. In recent weeks, the up-tick in bond yields is also pressuring utility stocks.

So, should you buy, sell, or hold Utilities?

Selected utility stocks such as ED, FE, and SO are oversold and due for a short-term bounce. Nimble traders can look here to make a quick buck at relatively low risk. With earnings outlook less than stellar, intermediate and long-term investors will be better off looking elsewhere.

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