The market is currently forecasting that the Federal Reserve will start cutting rates in the spring.
From there, the central bank is expected to continue lowering rates for at least a solid year and a half.
That means now is the perfect time to buy utility stocks.
Utilities are a classic example of a sector that is sensitive to interest rates.
The companies in this sector provide electricity, heating, telecommunications and other essential services.
They have steady customer demand, predictable cash flows, very capital-intensive operations and nice dividends.
But to pay for the expensive items they need in order to conduct business, utilities generally carry a heavier debt load than companies in other sectors.
That additional debt makes the sector sensitive to interest rate changes.
When rates go up, the interest that utilities have to pay on their debt goes up.
That has a negative impact on profits, which makes the stocks less attractive to investors.
When rates go down, the opposite happens.
Interest decreases, and profits go up.
This is a primary reason the utilities sector tends to do poorly when rates are rising and outperform when rates are falling.
Utility stocks also outperform when rates move lower because they often pay strong dividends, which become more and more attractive as rates continue to drop.
As rates fall, the yields on bonds and term deposits also decline.
But dividend yields don’t. And the further rates fall, the better utilities’ sizable dividends start to look.
Will History Repeat Itself?
We don’t have to speculate on how utility stocks perform when interest rates start falling.
One study looked at eight different interest rate hiking cycles and found that every single time interest rates hit their peak, it was a positive sign for the utilities sector.
History is telling us that utilities are poised to outperform.
And recent performance also tells us that the utilities sector is more than ready for a bull run.
Utility stocks have massively underperformed the S&P 500 in 2023.
Thanks to the big rally we’ve seen this year, I think the overall market is carrying more risk than usual.
I recently wrote about how seven huge tech stocks have been dominating the S&P 500 (and how those stocks are definitely not cheap).
After a roaring 2023, it is quite likely that these seven tech stocks will have a reversal in 2024… and that the S&P 500 will struggle because of it.
As the money leaves those stocks, some of it is going to go to dividend-paying utilities, which are much more attractively valued right now. The apparent peak in interest rates is also serving as a clear catalyst for utilities to lead the way in 2024.
In recent months, the utilities sector has been trading at its lowest price-to-earnings ratio since 2016.
And the 3.32% dividend yield on the Utilities Select Sector SPDR Fund (NYSE: XLU) is far superior to the 1.49% yield the S&P 500 offers these days.
That makes utilities a good place to hide out and wait for the Big Tech stocks to roll over.
The time is right to own utilities, and so is the price.
The Value Meter rates the Utilities Select Sector SPDR Fund – and the utilities sector as a whole – as being “Slightly Undervalued.”
If you have a stock that you’d like to have rated by The Value Meter, leave the ticker symbol in the comments section below.
— Jody Chudley
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Source: Wealthy Retirement