24/7 Wall St.

The utility sector has suffered the wrath of selling. As these are all high-dividend stocks and as many long-term investors had substantial capital gains, the investment community has been selling these handily over the past couple of weeks. Now that the election outcome is known, the trend has been to lock in big capital gains and to go ahead and get out of some of the dividends, which have become too narrow as the taxes are likely heading higher in 2013.

Tuesday was the first day that the downtrend was broken since election day, but investors were selling the utility sector even before the election. The realization that taxes are going up, and that capital gains taxes are going up, only added pressure on top of the fact that even the bullish Wall St. analysts were out routinely saying that utility stocks were trading at unprecedented premiums.

24/7 Wall St. has been telegraphing a bubble forming in the great dividend stocks and valuations that were priced for perfection and in the nose-bleed territory. By the way, we did not even address the higher and higher regulation and carbon duties here. That is just one more facet to a complicated story.

The Utilities Select Sector SPDR (NYSEMKT: XLU) was at $35.69 on election day and closed at $34.38 on Monday, before a small gain to $34.51 on Tuesday. The 52-week range is $33.18 to $38.54, so even the key ETF has pulled back by more than 10% from recent highs.

Duke Energy Corp. (NYSE: DUK) rose less than 1% to $62.01 on Tuesday, but this one had fallen from $64.07 on election day to $61.45 on Monday. Its 52-week trading range is $58.74 to $71.13, and its yield is back to 5% again now that shares are down so much from the peak.

American Electric Power Co. Inc. (NYSE: AEP) was up marginally to $41.34 on Tuesday, but this had fallen from $42.85, if you adjust for its dividend, down to $41.27 on Monday. It also traded above $45 in October. AEP has a 52-week range of $36.97 to $45.41, and its yield is back up to 4.6% now that shares have sold off.

Southern Co. (NYSE: SO) was down to $42.95 recently, and its 52-week range is $42.11 to $48.59. This one was at $44.14 on election day, and its yield is back up to 4.6% now.

PG&E Corp. (NYSE: PCG) recently closed at $40.85, against a 52-week range of $36.84 to $47.03. This one has held up better as it was at $41.91 on election day, perhaps under the guise that its California regulations are already known. Its yield is 4.5% as of now.

Read Also: MLPs Suffer Wrath of Tax and Dividend Selling

Our take is that some 10% to 15% would come out of the utility sector once reality set back in. With higher taxes on dividends and on capital gains now looking extremely probable rather than just likely, we are inclined to only look for opportunities selectively and on weakness. If there is another 5% or so, we would begin to consider a much more aggressive stance.

Keep in mind that PIMCO just gave more of an outlook only showing 4% to 5% for total return expectations from equities for the coming years. If these are yielding around 4.5% to 5.0% already, then the expectation at least from PIMCO would be that prices remain only stable and that the return comes from dividends. In turn, that stresses the notion that investors have to pick the utilities (and names in other dividend sectors) that offer the most value and protection against downside.

We are looking for some support in this sector, but are not quite ready to endorse taking risk yet. Today’s outcome of the political leaders and CEOs meeting with President Obama over forward tax strategies will have one massive influence over how investors (and 24/7 Wall St.) views this sector.

JON C. OGG