Last year, utilities benefited from a flight to safety. But through the first four months of 2023, the broader market has outperformed the sector as investors have become more optimistic the Federal Reserve will end interest-rate hikes and steer the economy to a soft landing. Should a recession emerge, investors could rekindle their interest in utilities. However, the sector's long-term risk-reward profile has historically trailed the overall market.
Taking a breather: Although interest rates spiked in 2022, with the 10-year Treasury yield increasing to 3.88%, the S&P Composite 1500 Utilities index returned 1.4% as investors eschewed growth sectors for less cyclical and defensive ones. However, the sector's -2.9% year-to-date return has lagged the overall market’s 6.5% gain.
Lower risk, returns: While the utilities index had lower volatility than the broader market across three, five and 10 years, the S&P Composite 1500 index had better risk-adjusted returns based on the Sharpe ratio.
Lower yield: The utilities index had a 3.1% dividend yield as of May 3, trailing 10-year Treasuries by 25 basis points. That continues last year's reversal of a 15-year streak in which utilities yielded more than the risk-free security at the end of the year.
Utilities vs. 10-year Treasuries
Potential growth: Utilities could see higher earnings growth from clean energy initiatives, such as electric vehicles, from the Inflation Reduction Act. Last year, the sector's earnings per share grew by 4.8%, and the consensus estimate calls for 7% and 8.7% growth in 2023 and 2024, respectively.
Earnings growth and profit margin
*Through May 3. **Through April 28. Sources: S&P Dow Jones Indices, Bloomberg LP, U.S. Department of the Treasury