The utility sector, which tends to outperform when the economy is in a downturn, staged a nice comeback, gaining 8.5% since the start of April. The solid returns have made it the top-performing S&P 500 sector of the second quarter and the third-best-performing sector year to date. The prospect of rate cuts this year, a slowing economy and solid industry fundamentals buoyed the rally.

While many stocks have powered the sector, we have highlighted five that led the way higher in the past month and saw positive earnings estimate revision for the current fiscal year. Additionally, these stocks have a Zacks Rank #1 (Strong Buy), #2 (Buy) or #3 (Hold). These are California Water Service Group (CWT Quick QuoteCWT - Free Report) , TransAlta (TAC Quick QuoteTAC - Free Report) , American Water Works Company (AWK Quick QuoteAWK - Free Report) , NRG Energy Inc. (NRG Quick QuoteNRG - Free Report) and American Electric Power Company Inc. (AEP Quick QuoteAEP - Free Report) .

Here, we discuss some strong reasons for the outperformance of the sector. These factors are likely to fuel the rally in the coming weeks as well:

Defensive Investment

Being a low-beta sector, utility is relatively protected from large swings (ups and downs) in the stock market and is thus considered a defensive investment or safe haven amid economic or political turmoil.

The world's largest economy is showing signs of a slowdown, thus raising bets for defensive investments. The economy added a lower than expected 175,000 jobs last month, and the unemployment rate unexpectedly jumped to 3.9%. After growing for 15 consecutive months, U.S. service sector activity also unexpectedly contracted in April. In another recent weak data, consumer confidence dropped last month to the lowest since mid-2022. Additionally, the United States had a weak start to the year due to lower consumer and government spending amid growing inflation. The economy expanded at the slowest pace in two years, with GDP rising 1.6% annually in the first quarter.

Fed “No Rate Hike” Memo

Being interest rate-sensitive, utility stocks got a boost from the Fed’s message. The Fed signaled that its fight against inflation will continue for a longer period, setting the stage for a period of extended higher rates but no rate hikes. In its latest meeting, the Fed kept interest rates steady at a 23-year high in the range of 5.25% to 5.5%, citing a “lack of further progress” on inflation. Powell reiterated that it will now take longer than expected for the Fed to reach the confidence that inflation is moving sustainably down to 2%.

As utilities require huge infrastructure, which creates a massive debt burden and interest obligation, the Fed’s “no rate hike” memo lifted the space.

Solid Industry Fundamentals

The sector is among the beneficiaries of the artificial intelligence (AI) craze and a boom in data center growth that will likely boost electricity demand for companies within the utilities sector. Additionally, the re-shoring of manufacturing, which requires more power for battery plants and chipmaking factories, and the setting up of charging stations for electric vehicles are expected to drive a surge in energy demand. According to a Wells Fargo analyst, "power demand in the United States is actually growing for the first time in 15 years.”

Further, an ever-increasing population continues to push up demand for utility supplies like water, gas and electricity.

Best-Performing Stocks

California Water Service is one of the largest investor-owned water utilities in the United States. The stock has jumped 19.7% in a month and saw a solid earnings estimate revision of 90 cents for this year. It has an estimated earnings growth rate of 246.1%.

California Water Service has a Zacks Rank #1 currently. You can see the complete list of today’s Zacks #1 Rank stocks here.

TransAlta is Canada's largest non-regulated electric generation and marketing company. It has risen 16.7% in a month and saw a solid earnings estimate revision of 22 cents for this year. TransAlta’s earnings are expected to decline 54.1%.

The stock has a Zacks Rank #3.

American Water is a water supply and wastewater service provider. It provides essential water services to more than 14 million customers in 24 states and acquires small water service providers to expand its customer base. The stock has gained 17% in a month and saw a positive earnings estimate revision of a couple of cents for this year.

At present, American Water has a Zacks Rank #3

NRG Energy is engaged in the production, sale and delivery of energy and energy products and services to residential, industrial as well as commercial consumers in major competitive power markets in the United States. The stock has gained about 15% and has an estimated earnings growth of 26.4% for this year.

NRG Energy saw a solid earnings estimate revision of 10 cents over the past 30 days for this year and has a Zacks Rank #3.

American Electric is a public utility holding company, which, through directly and indirectly owned subsidiaries, generates, transmits and distributes electricity, natural gas and other commodities. The stock has risen 13.2% in a month and saw a positive earnings estimate revision of 3 cents for this year.

AEP is expected to post an earnings growth of 6.1% for this year. It has a Zacks Rank #3.

Image Source: Zacks Investment Research