The trade in 2011 was to go out and turn utility stocks into the new investment for retirees seeking income. They couldn’t exactly get any big yield in certificates of deposit, and loaning Uncle Sam money for ten years at a rate of less than 2% was just not very exciting nor very rewarding. Banks tanked in 2011 while the S&P Utility Sector was actually the best sector with close to 15% gains plus the high value dividends.
Each year, you often see the same trend over and over: “Buy the weakest sectors and dump the strongest.” Maybe there is a value in the weakest links and maybe too much a premium in the strong sectors. The Financial Select Sector SPDR (NYSE: XLF) is off to a great start in 2012, while the Utilities Select Sector SPDR (NYSE: XLU) has been very weak.
All you have to do is look at the extremes… Bank of America Corporation (NYSE: BAC) was the worst DJIA stock of all in 2011 but now shares are up literally 19% since the end of 2011. J.P. Morgan Chase & Co. (NYSE: JPM) is even up over 9% since the end of 2011 and it has earnings due in just two days. With the huge discounts to book value, the thought is that there is value even with the headwinds facing the banking sector’s ability to generate solid earnings. BofA was recently shown as one of the DJIA stocks with the most implied upside.
What about American Electric Power Co., Inc. (NYSE: AEP) bounced a bit off the lows in the last two days but its shares had been down almost 2% so far this year after just six trading sessions. Duke Energy Corporation (NYSE: DUK) was down almost 3% from the end of 2011 before a small bounce. Many utilities are trading at close to 13-times earnings now, which historically could imply a premium being paid to get those dividend yields of 4% and higher. AEP remains in our 2012 Model Dividend Portfolio and that will only change if the price rises too much.
All you are seeing is a reverse of the flight to safety because many believe that the economy has escaped another recession or that the worst was priced in. Before giving up entirely, interest rates are likely to remain very low and that drives investors toward stable income sources. Utilities also win from low interest rates because of borrowing costs. As far as the banks, the woes of Europe are not yet gone and the utilities have little to no real exposure there. If everyone is wrong about no second recession, which has better visibility… utilities or banks?
JON C. OGG