The Federal Reserve abstained from raising rates this month, but said that near-term risks to the economic outlook have diminished. This can be read as a willingness to raise rates in the fall. Yet, all data needs to be uniformly strong and, with inflation remaining below the desired target, it is expected that a rate hike is not all too imminent. Presidential elections are also ahead which might lead to volatility, while the effects of Brexit are as yet unclear. Given these uncertainties, the Fed is expected to tread a cautious path.
The bottom line is a still low interest rate environment, which makes investments in utilities a prudent option. Low interest rates would be good for utility stocks due to a decrease in cost of capital, increase in profitability and decreased demand for treasuries.
Fed Keeps Rate Unchanged in July
At the policy meeting that ended on Wednesday, 9 of the 10 members voted in favor of leaving the federal funds rate at 0.25% to 0.5%. This came as no surprise, as the Fed was fretting about a wide range of risks including a slowdown in U.S. economic growth in the first quarter, uncertainty about China’s economic outlook and Britain’s vote to leave the Eurozone. In fact, Fed Chair Janet Yellen had earlier cautioned that a Brexit would “usher in a period of uncertainty” and fuel volatility in world markets.
U.S. stocks, however, showed remarkable resilience, shrugging off the initial shock of the Brexit decision to climb to record highs. As a result, the Fed concluded that the “near-term risks to the economic outlook have diminished.” More so, the U.S. economy showed signs of strength in June, which did not go unnoticed by the Fed. The central bank pointed out that the labor market has “strengthened” last month. The Fed also said that household spending is “growing strongly” as buyers are more willing to spend (read: 5 Stocks to Buy on Rising Consumer Spending).
Based on these upbeat statements data dependent analysts might jump to the conclusion that a rate hike is round the corner. On the contrary, the Fed gave no hint as to when it might resume the rate hikes that took off last December. The Fed adopted a guarded stand, with the statement still remaining void of key components to justify further rate hikes.
No Clear Picture of Further Rate Hike
The Fed said that inflation continues to lag its desired target range. Even though some may argue that the core Consumer Price Index went up 2.3%, the Fed's preferred inflation gauge, the Personal Consumption Expenditure Index, remained below its 2% target. The index recorded current inflation at 1.6%, which continues to hover below the target since 2012. For the Fed to hike rates, data needs to be consistently strong. But, in the current case, inflation remaining low for a sustained period fails to fulfill such requirements (read: Fed’s Favorite Inflation Measure Remains Stuck at 1.6%).
In fact, the latter part of the year into which we are headed should be fraught with volatility given the upcoming elections. Against this backdrop, the possibility of a rate hike is highly unlikely. We are also still not clear about the fallout of Brexit on major economies. Both the Bank of England and European Central Bank restrained themselves from taking any further stimulus measures, judging that it was too early to determine the economic fallout. The Fed is also maintaining a wait-and-watch approach before taking the all-important rate hike decision.
How Utilities Benefit From Ultra-Low Rates?
Without clear indication that the U.S. economy is on a firm, sustainable footing, the Fed is expected to continue to exercise patience. Low level of business investment will do little to help Fed hike rates. Fed funds futures indicated that the odds of a rate hike remain at 30% in September and 48% in December, both below the half-way mark.
In this context, companies that are part of the utilities sector stand to benefit the most. Lower interest rates mean a decrease in the cost of capital, a basic requirement of such companies. Utility companies are capital intensive since they require a continuous inflow of funds to carry out their operations and upgrade infrastructure. Lower interest rates or for that matter a decrease in the debt level will have a positive impact on their credit ratings.
Top 4 Utility Stocks to Invest In
For these aforementioned reasons, investing in utility stocks will be a judicious decision. As we are in the thick of the earnings season, lets’ see what the projections are saying. The overall utility sector’s earnings are expected to grow a solid 20.7% in Q2, a sharp about turn from the 6.9% earnings decline registered in the preceding quarter, according to the Earnings Trends report. (Read: If You Seek a Stable Portfolio? Utilities Are a Must)
We have selected four utility stocks that possess a Zacks Rank #2 (Buy). Additionally, we have narrowed down our search with a VGM score of ‘A’ or ‘B’. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners.
CMS Energy Corp. (CMS - Free Report) focuses primarily on its principal subsidiary, Consumers Energy, an electric and natural gas utility serving about 6.5 million of Michigan’s 10 million residents. CMS has a VGM score of ‘B’. CMS’ year-to date return is an encouraging 23.8%. The company’s estimated earnings growth rate for this year is 6.8%.
ONEOK, Inc. (OKE - Free Report) purchases, gathers, compresses, transports, stores and distributes natural gas. It also leases pipeline capacity to others. OKE has a VGM score of ‘B’. OKE’s year-to date return is a whopping 78.3%. The company’s estimated earnings growth rate for this year is 13.1%.
PG&E Corporation (PCG - Free Report) engages principally in the business of providing electricity and natural gas distribution and transmission services throughout most of Northern and Central California. PCG has a VGM score of ‘B’. PCG’s year-to date return is a solid 20.2%. The company’s estimated earnings growth rate for this year is 20.1%.
DTE Energy Co (DTE - Free Report) is a Detroit-based diversified energy company involved in the development and management of energy-related businesses and services nationwide. DTE has a VGM score of ‘A’. DTE’s year-to-date return is a sturdy 21.3%. The company’s estimated earnings growth rate for this year is 3.9%.
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