Tags: interest rates | Treasury | utilities | XLU

Don't 'Overdump' Utility Shares

By    |   Wednesday, 05 Jun 2013 07:42 AM

High dividend-paying (and high-yield) utility stocks have traditionally been viewed as an alternative to U.S. government Treasury bonds. As you can imagine, since Treasury bond rates have risen in recent weeks, shares in utilities have come under pressure.

The popular Utilities Select Sector SPDR (XLU) exchange-traded fund dropped nearly 10 percent in May, its biggest selloff since 2009.

Much like the purported "inverse relationship" between broader stock indexes and interest rates (which I devastated last week), the alleged inverse relationship between interest rates and utility shares is overdone as well.

It is far easier to view the recent selloff in utilities as a normal correction in a very strong sector bull market. Even given their recent swoon, these stodgy utility stocks are up 72 percent from their lows five years ago — and that does not include their dividends. Compare this with a 27 percent gain for long-term Treasury bonds.

What will help keep the pot boiling under these shares is their rising dividend payments. Treasury bond cash payments are fixed over the 30-year life of the bonds. Thus you can, and will, be savaged by inflation. Even at today's modest inflation rate of 1.5 percent annually, while locked in for 30 years the real purchasing power of your Treasury bond payment would shrink by more than half.

In contrast, as earnings and cash flow rise, so do the dividend paid by utility companies. A decade ago, XLU paid about $1.00 in dividends. Now it is closer to $1.40.

This doesn't mean that investors should ignore economic data. But it does mean you should not be buffaloed by simplistic analyses that don't even stand up to cursory historical analysis. Interest rates rose sharply in the spring of 2009, but XLU shares soared along with the rest of the market. Chicken Littles would have left more than a 25 percent capital gain on the table.

Rates rose again in the final five months of 2010. XLU? A far more modest 6 percent gain, but nothing to sniff at.

And while we are on the subject, interest rates began to rise almost 10 months ago, in August of 2012. Only recently have XLU shares swooned. The explanation must lie elsewhere.

Concentrate on utility shares in the fast-growing, business-friendly sections of the South and Southwest. Their growth in revenues, earnings and cash flow will continue to support dividend growth for decades to come.

That dividend growth will easily overwhelm short-term fluctuations in Treasury rates, as it has in the past. Even if XLU dividends grow as slowly over the next 10 years as they did in the difficult past decade, XLU will pay a cash dividend of nearly $1.96 per share by 2023. At a current price for XLU of $38 a share, that is better than a 5.1 percent yield annually on your initial investment. And this is before any capital gains that might come over that time span.

Sure beats locking in 3.28 percent from now till kingdom come. Let the Chinese buy our Treasury bonds and get what they deserve.

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Gary-Jakacky
High dividend-paying (and high-yield) utility stocks have traditionally been viewed as an alternative to U.S. government Treasury bonds. As you can imagine, since Treasury bond rates have risen in recent weeks, shares in utilities have come under pressure.
interest rates,Treasury,utilities,XLU
510
2013-42-05
Wednesday, 05 Jun 2013 07:42 AM
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