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Forget Gold, Bet on Utilities ETFs for a Safe Haven

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Stock markets have been in good shape in recent months despite the rise in COVID-19 cases and a lackluster economic scenario. But many investors fear that the rally doesn’t have legs. “Sometimes the market rallies and it makes perfect sense. Then there are days… when I can’t take how stupidly bullish this market can be,” said CNBC Mad Money host Jim Cramer, as quoted on MarketWatch.

Michael Wilson, chief U.S. equity strategist at Morgan Stanley, and his colleagues believe that “the most likely outcome remains a 10% correction in the broader index led by the beneficiaries before the recovery and bull market continues.”

Presidential election uncertainty, massive pandemic stimulus and again embittering U.S.-China relations may worsen the market momentum. The winning index of the pandemic — the Nasdaq and the winning sector technology — may see overvaluation concerns.

Against this backdrop, investors’ search for safe havens makes sense. With the safe asset gold peaking an all-time high and currently losing a bit (gold bullion fund GLD down about 6% in the past five days), investors should dig into other safe assets. One such area is the utilities sector which has compelling valuations too.

Why Tap Utilities Now?

Utilitiesis a non-cyclical sector that thrives during an economic slowdown. As the virus scare stalled the global economy,long-term bond yields took a hit. As a result, utilities benefited a great deal being a rate-sensitive sector. This is because high-yielding utilities perform well in a low-rate environment.

The sector requires huge infrastructure, which places a massive debt burden and the resultant interest obligation on its operators. Trump’s executive order on stimulus should help boost the sector.

Per the Earnings Trends issued on Aug 5, 2020, about 69% of the utilities sector under the S&P 500’s market cap has reported Q2 earnings. So far, earnings growth has been 16.2% with a 75% beat ratio while revenues declined 7.4% with a 6.3% beat ratio.

The results came in stellar against a 35% drop in the S&P 500 earnings on 10.8% lower revenues. Utility earnings are expected to witness a 1.1% increase in Q2 but a 3.5% decline in Q3. The figures are pretty upbeat in comparison to the lackluster shape of the other sectors.

As far as valuation is concerned, the Dow Jones Utility Average Index currently boasts P/E (ttm) of 24.78X versus 26.49X recorded in the year-ago period. This calls for undervaluation if we compare with the Dow Jones Industrial Average that currently has a P/E of 28.14X versus 18.73X noted earlier.

Even if the virus scare subsides and markets recoup, utilities are likely to maintain strength. This is because the Fed may remain extremely patient for quite a long period and rates are likely to be at subdued levels.

From the yield point of view, the utilities index is better positioned at 3.17% annually versus 2.40% offered by the broader Dow Jones Index.

ETFs in Focus

Below we highlight a few utilities ETFs that could be solid plays now (see all Utilities/Infrastructure ETFs here).

Invesco DWA Utilities Momentum ETF (PUI - Free Report) — Up 7.4% past month

Reaves Utilities ETF (UTES - Free Report) — Up 6.7% past month

Vanguard Utilities ETF (VPU - Free Report) — Up 6.3% past month

Utilities Select Sector SPDR Fund (XLU - Free Report) — Up 6.3% past month

Fidelity MSCI Utilities Index ETF (FUTY - Free Report) — Up 6.2% past month

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