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What Will To Happen To Utility Stocks If The Fed Raises Rates? October 2015 Edition

Summary Since the September 17th Fed meeting, utilities have gone up by 7% vs. a 2% gain in the S&P 500. Several utility valuation metrics show the group becoming more expensive during this period. If the Fed increases rates at this month’s meeting, the impact on utilities would likely be greater today than it would have been last month. Last September the big question was whether or not the Fed would raise interest rates. In my previous article I discussed what a rate increase would mean to utility stocks. These stocks have been outperformers since the decision to hold rates steady, with the Philadelphia Utility Index (UTY) up 7% over the last month, while the S&P 500 is only up 2%. Chart 1 (click to enlarge) Source: FactSet Even with the outperformance these past few weeks, utilities are still behind the market year-to-date. Chart 2 (click to enlarge) Source: FactSet It appears that utility dividend yields have basically moved in line with the 10-year Treasury yield. Both yields have declined about 20bp since the last Fed meeting, leaving the spread between the two rates essentially flat. Chart 3 (click to enlarge) Source: FactSet So with the spread versus the 10-year Treasury one standard deviation above the average, utilities look cheap relative to Treasuries. This is the same situation we were in one month ago. One could argue that Treasuries aren’t the optimal comparison for utility dividends, so I have also completed an analysis comparing utility dividend yields to BBB corporate bonds with a 7-10 year maturity. These bonds are of lower quality than Treasuries, but still are investment grade. An investor would likely consider these bonds in addition to utility stocks when looking for extra yield. Below is a chart showing how the spread between the yields has moved so far this century. Chart 4 (click to enlarge) Source FactSet It is interesting to see that before the financial crisis corporate BBB bonds were typically yielding a few percentage points more than utility stocks, with the exception during the 2002 to 2003 period when Enron and other issues hit the utility sector hard. Since the financial crisis, utility yields have been trading close to BBB corporates. This seems to imply that investors looking for more yield consider these two investment areas as at least partial substitutes for each other. Looking at the chart starting in 2014 helps give a better feel for what is happening today. Chart 5 (click to enlarge) Source FactSet Utilities hit their peak earlier this year, and that is at about the time when the widest spread versus corporates was reached. Since the last Fed meeting it looks like the spread has widened slightly, making utilities a little more expensive than they were versus BBB corporates. But the change hasn’t really been that great. While utilities look cheap compared to BBB corporates and Treasuries, if you just look at the historic dividend yield of the group things start looking a bit more expensive. Here is a chart showing the historic utility dividend yield since 2000. Chart 6 (click to enlarge) Source: FactSet Zooming into the data since 2014 gives us this chart: Chart 7 (click to enlarge) Source: FactSet You can see that these stocks got really expensive earlier this year and that valuations started coming in leading up to the September Fed meeting. Since then there is a definite trend of the utilities getting more expensive as the dividend yield has decreased. Historic P/E ratios make the utilities look even more expensive. Chart 8 (click to enlarge) Source: FactSet My previous article used data through September 7th, and that was basically the year’s low point for utility P/E ratios. Since then utility P/Es have sharply risen, and as of October 20 are at 16.25x. This is about one standard deviation above the average since the turn of the century. This increase in utility P/Es is likely driven by a response to interest rates rather than to issues specifically related to the utility industry. For example, UTY components Exelon (NYSE: EXC ) and FirstEnergy (NYSE: FE ) should be benefiting from positive trends on the merchant generation front (see an example here ). However, these companies actually lagged the UTY over the last month. With utilities moving in step with interest rates over the last month it seems like the potential negative impact from a rate increase by the Fed is greater than it was in September. Utilities aren’t as expensive as they were in the beginning of 2015, but they have definitely bounced well off of their lows for the year. Conclusion Utility investors who feel the Fed will raise rates at the October meeting may want to think about trimming some positions. Xcel (NYSE: XEL ) and Ameren (NYSE: AEE ) are examples of utilities that have outperformed the UTY over the last month, and would be good potential trimming candidates if you are concerned about the impact of a rate increase. AEE’s outperformance may have extra interest rate sensitivity because of the dividend increase they announced on October 9th. The biggest ETF impacted by these factors would be the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ). Utility valuations aren’t rich enough to say with certainty that a Fed increase will hit the stocks hard, but the risk is definitely greater than it was last September.

What Will Happen To Utility Stocks If The Fed Raises Rates? October 2015 Edition

Summary Since the September 17th Fed meeting, utilities have gone up by 7% vs. a 2% gain in the S&P 500. Several utility valuation metrics show the group becoming more expensive during this period. If the Fed increases rates at this month’s meeting, the impact on utilities would likely be greater today than it would have been last month. Last September the big question was whether or not the Fed would raise interest rates. In my previous article I discussed what a rate increase would mean to utility stocks. These stocks have been outperformers since the decision to hold rates steady, with the Philadelphia Utility Index (UTY) up 7% over the last month, while the S&P 500 is only up 2%. Chart 1 (click to enlarge) Source: FactSet Even with the outperformance these past few weeks, utilities are still behind the market year-to-date. Chart 2 (click to enlarge) Source: FactSet It appears that utility dividend yields have basically moved in line with the 10-year Treasury yield. Both yields have declined about 20bp since the last Fed meeting, leaving the spread between the two rates essentially flat. Chart 3 (click to enlarge) Source: FactSet So with the spread versus the 10-year Treasury one standard deviation above the average, utilities look cheap relative to Treasuries. This is the same situation we were in one month ago. One could argue that Treasuries aren’t the optimal comparison for utility dividends, so I have also completed an analysis comparing utility dividend yields to BBB corporate bonds with a 7-10 year maturity. These bonds are of lower quality than Treasuries, but still are investment grade. An investor would likely consider these bonds in addition to utility stocks when looking for extra yield. Below is a chart showing how the spread between the yields has moved so far this century. Chart 4 (click to enlarge) Source FactSet It is interesting to see that before the financial crisis corporate BBB bonds were typically yielding a few percentage points more than utility stocks, with the exception during the 2002 to 2003 period when Enron and other issues hit the utility sector hard. Since the financial crisis, utility yields have been trading close to BBB corporates. This seems to imply that investors looking for more yield consider these two investment areas as at least partial substitutes for each other. Looking at the chart starting in 2014 helps give a better feel for what is happening today. Chart 5 (click to enlarge) Source FactSet Utilities hit their peak earlier this year, and that is at about the time when the widest spread versus corporates was reached. Since the last Fed meeting it looks like the spread has widened slightly, making utilities a little more expensive than they were versus BBB corporates. But the change hasn’t really been that great. While utilities look cheap compared to BBB corporates and Treasuries, if you just look at the historic dividend yield of the group things start looking a bit more expensive. Here is a chart showing the historic utility dividend yield since 2000. Chart 6 (click to enlarge) Source: FactSet Zooming into the data since 2014 gives us this chart: Chart 7 (click to enlarge) Source: FactSet You can see that these stocks got really expensive earlier this year and that valuations started coming in leading up to the September Fed meeting. Since then there is a definite trend of the utilities getting more expensive as the dividend yield has decreased. Historic P/E ratios make the utilities look even more expensive. Chart 8 (click to enlarge) Source: FactSet My previous article used data through September 7th, and that was basically the year’s low point for utility P/E ratios. Since then utility P/Es have sharply risen, and as of October 20 are at 16.25x. This is about one standard deviation above the average since the turn of the century. This increase in utility P/Es is likely driven by a response to interest rates rather than to issues specifically related to the utility industry. For example, UTY components Exelon (NYSE: EXC ) and FirstEnergy (NYSE: FE ) should be benefiting from positive trends on the merchant generation front (see an example here ). However, these companies actually lagged the UTY over the last month. With utilities moving in step with interest rates over the last month it seems like the potential negative impact from a rate increase by the Fed is greater than it was in September. Utilities aren’t as expensive as they were in the beginning of 2015, but they have definitely bounced well off of their lows for the year. Conclusion Utility investors who feel the Fed will raise rates at the October meeting may want to think about trimming some positions. Xcel (NYSE: XEL ) and Ameren (NYSE: AEE ) are examples of utilities that have outperformed the UTY over the last month, and would be good potential trimming candidates if you are concerned about the impact of a rate increase. AEE’s outperformance may have extra interest rate sensitivity because of the dividend increase they announced on October 9th. The biggest ETF impacted by these factors would be the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ). Utility valuations aren’t rich enough to say with certainty that a Fed increase will hit the stocks hard, but the risk is definitely greater than it was last September.

ETF Update: An Unintended Focus On China A-Shares

Summary Every week, Seeking Alpha aggregates ETF updates in an effort to alert readers and contributors to changes in the market. There were 5 ETF launches over the last 2 weeks, with 3 of those launches focusing on China A-shares. Have a view on something that’s coming up or a new fund? Submit an article. Welcome back to the SA ETF Update. My goal is to keep Seeking Alpha readers up to date on the ETF universe and to gain some visibility, both for the ETF community, and for me as its editor (so users know who to approach with issues, article ideas, to become a contributor, etc.) Every weekend, or every other weekend (depending on the reader response and submission volumes), we will highlight fund launches and closures for the week, as well as any news items that could impact ETF investors. After the flood of launches 2 weeks ago, the last two weeks were low key in comparison. This was great for me as an editor a Seeking Alpha with Earnings Season in full swing, so I decided to combine this week and last week’s launches into one ETF Update post. Fund launches for the week of October 12, 2015 Fund launches for the week of October 19, 2015 Deutsche Bank rolls out a hedged alternative to ASHR (10/20) : The Deutsche X-trackers CSI 300 China A-Shares Hedged Equity ETF (NYSEARCA: ASHX ) will provide access to China A-share equities while mitigating exposure to fluctuations between the value of the Chinese renminbi and the U.S. dollar. This is a variation on the already popular Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (NYSEARCA: ASHR ). CSOP Asset Management launched 2 China ETFs as well (10/20) : There seemed to be a trend on the 20th, as CSOP Asset Management launched two new China focused ETFs to accompany its first fund, the CSOP FTSE China A50 ETF (NYSEARCA: AFTY ). The CSOP MSCI China A International Hedged ETF (NYSEARCA: CNHX ) is another currency hedged China A-shares fund, and the CSOP China CSI 300 A-H Dynamic ETF (NYSEARCA: HAHA ) tracks the CSI 300 Smart Index, which will switch between A and H shares of CSI 300 Index constituent companies based on their relative prices. This is a tricky one, so make sure to do your homework before diving in. State Street Global Advisors brings a new U.S. dividend fund to market (10/22) : The SPDR S&P 500 High Dividend ETF (NYSEARCA: SPYD ) tracks an index of the top 80 dividend-paying securities listed on the S&P 500, based on dividend yield. State Street is of course best known as the issuer behind the SPDR S&P 500 ETF (NYSEARCA: SPY ). Fund closures for the weeks of October 12 and 19, 2015 Direxion Daily 7-10 Year Treasury Bull 2x Shares ETF (NYSEARCA: SYTL ) Direxion Daily Mid Cap Bull 2x Shares ETF (NYSEARCA: MDLL ) Direxion Daily Basic Materials Bull 3x Shares ETF (NYSEARCA: MATL ) Have any other questions on ETFs or ETNs? Please comment below and I will try to clear things up. As an author and editor I have found that constructive feedback is the best way to grow. What you would like to see discussed in the future? How can I improve this series to meet reader needs? Please share your thoughts on this first edition of the ETF Update series in the comments section below. Have a view on something that’s coming up or a new fund? Submit an article.