2019 outlook: Utilities

Amid rising volatility and questions about peaking growth, safe-haven utilities are poised for a leadership role.

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Equity markets experienced a distinct uptick in volatility in 2018 amid concerns about global trade, geopolitical uncertainty, rising interest rates, and a flattening yield curve. Simultaneously, the 10-year-old bull market, one of the longest economic expansions in history, finally began to show some signs of aging. Peaking growth in global economies and company earnings, combined with tightening financial conditions by central banks in developed countries, emerged as real risks for equities. During periods of such volatility, sector leadership can shift quickly, which is exactly what we have witnessed this year. Earlier in 2018, companies in areas such as information technology were the primary drivers of equity performance, as measured by the S&P 500® index, and utilities lagged. However, in the second half of 2018, as the investment markets became more volatile, tech stocks pulled back, and utilities rose to the top.

Utilities have historically been viewed as a safe haven, providing ballast for a diversified portfolio when markets turn downward, and for good reason. They are primarily domestic, U.S.-based companies, and are less economically sensitive, as most consumers pay their utility bills during both strong markets and recessions. As of October 31, the utilities sector had an average yield of 4%—the highest of any S&P 500 sector—and was expected to deliver 5% to 6% earnings growth. Utilities have historically distinguished themselves as the best performers in down equity markets, dramatically outperforming the broader index during six volatile years since 2000 (See chart below). Utilities also overcame losses from earlier in 2018 to deliver returns on par with the broader market as of the same time period. From my vantage point, if the new normal for the equity markets is a period of lower returns, these fundamentals for utilities may make them an attractive investment option as part of a broader portfolio.

Utilities have been out of favor since interest rates bottomed in 2016, broadly underperforming the other 10 sectors within the S&P 500. Given the current environment, I believe utilities are poised to rebound in 2019 and rotate back into a market leadership position, especially as the likelihood of an economic slowdown or recession increases.

Regardless of the economic and investment backdrop, I intend to continue to seek utilities with solid fundamentals and above-average dividend growth at reasonable prices. For example, we have seen significant potential in companies within the independent power producers and energy traders segment, which have benefited from solid free-cash-flow yields and improving balance sheets. In addition, beneath the surface of the low-growth industry are some big secular changes that benefited some utilities, such as the shift to renewable energy. Some utility companies have built leadership positions in the development of renewable power generation, allowing them to grow their earnings and dividends at higher rates.

Next steps to consider

Research the Fidelity® Select Utilities Portfolio (FSUTX).

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Go back to the full 2019 sector outlook.

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