When you think about classic defensive areas of the equity market, the utilities sector likely springs to mind - traditionally offering low volatility returns, relatively insulated from the vagaries of the economic cycle, but also little in the way of earnings growth.
However, industry dynamics are changing, to the extent that this conventional view of the utilities sector is looking increasingly outdated. In fact, we believe utilities today could provide some of the best long term, risk adjusted, return opportunities of any US equity market sector.
A new era
Historically, utility returns were driven almost entirely by dividend yields and these were, in turn, highly correlated with yields available on US Treasury and corporate bonds. For investors looking for growth, the utilities sector was not the place to be.
During the period from 1986 to 1998, for example, earnings growth for companies in the S&P 500 Utilities Index was effectively flat. In comparison, earnings for companies in the broad S&P 500 Index rose 159%, or at an 8.5% compound annual growth rate (CAGR).
More recently, however, this picture has changed markedly. Utility company earnings growth has accelerated, while earnings growth for the broad market has slowed - narrowing the earnings gap considerably. Over the decade ended 2017, for example, earnings per share for the S&P 500 Utilities Index grew at a 4.1% CAGR, compared with 6.1% for the S&P 500 (See Fig. 1) .
However, industry dynamics are changing, to the extent that this conventional view of the utilities sector is looking increasingly outdated. In fact, we believe utilities today could provide some of the best long term, risk adjusted, return opportunities of any US equity market sector.
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