The Market’s Watching Nvidia, I’m Watching Utility ETFs

The Market’s Watching Nvidia, I’m Watching Utility ETFs

The sector is no longer the investing version of watching paint dry.

RobIsbitts310x310
|
Reviewed by: Ron Day
,
Edited by: Kent Thune

What an exciting week this is! No, I don’t mean Nvidia’s earnings report, though that ought to interest a few people on Wall Street. There is a double-digit number of Fed speakers on tap this week, which means we should all drink bottled beer instead, because that tap may not be safe for our wealth.

This week is exciting for a different reason, one that has made the softer side of equity investing exciting since late last year. Here’s a quick quiz to get you in the right frame of mind:

  1. Which ETF has the better return this year through last Friday, the $268 billion Invesco QQQ Trust (QQQ) or the $14 billion Utilities Select Sector SPDR ETF (XLU)? Answer: XLU, up 15.2% year to date versus 10.5% year to date for QQQ.
  2. Which of those two ETFs has a better return over the last six months, which has been heralded as one of the strongest rallies in recent memory? Also, XLU, up 18.2% to QQQ’s 17.5%.
  3. Over the past three years, which of that pair has done better? OK, this is where XLU’s luck runs out. It is up 22%, about half that of QQQ. That should not shock anyone.  

However, XLU is slightly ahead of the Invesco S&P 500 Equal Weight ETF (RSP) over that time. That means a capitalization-weighted index of all utility stocks in the S&P 500 has been in step with the average S&P 500 stock. That should surprise a lot of investors and investment advisors.

XLU, Utility Stocks: What's Next?

This is why successful investing is about so much more than what we see on the surface. We all get caught up in the headlines. It is human nature. But the difference between long-term success and those who confuse speculation with investing is the degree to which they are willing to look beneath the surface and do so with an expectation that there is usually something there to find.  

Utility stocks are those traditionally boring companies that make it so that we can type articles or read them on our computers at home and get a clean glass of water when we get up for a break. Or are they starting to be perceived as something more? I’ll admit that when XLU and many of its components started to look very attractive on the charts earlier this year, I assumed it was the market sniffing out lower interest rates.  

Utilities are a very small part of the S&P 500 at just 2.6% of that index. But XLU’s yield of 3.0% is more than twice that of the S&P 500’s 1.3%. And along with energy and REITs, utilities are the only sector with a dividend yield of at least 3%. Since so much institutional money is mandated to only own stocks and be fully always invested, utilities have traditionally been considered a bond surrogate for such investors. In addition, they provide essential services, and represent a big part of the United States’ increased commitment to infrastructure spending and development.  

Nvidia and Utility ETFs: A Surprising Commonality

But as many analysts have recently highlighted, there is a fresh reason that investors are chasing this sector higher. And ironically, it is a very “Nvidia-style” reason. Utilities provide the power that is used to enhance artificial intelligence (AI) systems.  

That is, the expression “why have the cow when you can have the milk for free” doesn’t apply here at all. AI is a driver of our future, but without the electricity to make it run, it is merely an idea, a concept. So, for now, XLU and its peers are riding the coattails, putting traditional utility investors in a strange position. This is probably not how they expected to receive market-leading returns.

That, in turn, creates potential concerns about how sustainable the returns in this sector will be. A 3% yield is nice, but not if the ETFs producing it give back 20% in price simply because the market’s buzz wore off.

There are wide range of utility ETFs that can be identified and researched at etf.com. Whether investors and advisors are invested in the sector more directly through something like XLU, or through a broader dividend ETF that has a chunk allocated to utility stocks, this is a good time to track this sector closely. 

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.