When that recession we’ve been waiting for finally hits, expect utilities stocks to stand tall.
What a refreshing change that will be for investors who own shares of utility companies. To a surprising extent for a supposedly tame sector, the past two years have been awful. This explains a recent query from a reader asking if he should hang on to his utilities stocks after the beating they’ve suffered.
Selling these stocks now would mean locking in some disappointing results, so the answer is yes. The S&P/TSX Capped Utilities Index lost 10.6 per cent in 2022 and then was basically flat in 2023. So far this year, the index pulled back again by a modest amount.
Behind these returns is the rising rate trend of the past two years. Investors tend to treat utilities shares like bonds – when rates go up, the price of these securities goes down. The Bank of Canada’s rate announcement earlier this week highlights the outlook for lower rates this year. A sustained decline in interest rates would be a big help to the utilities sector.
Utilities are a classic defensive sector – expect them to outperform if and when the economy finally does lapse into recession. Another reason to hang on to stocks in this sector is the dividend income. The S&P/TSX Capped Utilities Index yields about 4 per cent, which is reasonably good but not outstanding in today’s high rate world. It should be noted that the after-tax return in non-registered accounts would look comparatively better thanks to the dividend tax credit.
Utilities stocks tend to be dividend growers, so you should expect an increasing amount of income each year. Almost one-quarter of the S&P/TSX Capped Utilities Index is accounted for by Fortis Inc. (FTS-T), which last September announced a dividend hike for the 50th year in a row. The most recent increase came in at 4.4 per cent, which beats the latest inflation rate by a full percentage point (disclosure note: I own some Fortis shares).
Not all dividend stocks are as steady as Fortis. Algonquin Power & Utilities Corp. (AQN-T) slashed its dividend by 40 per cent a year ago, a move that hasn’t addressed investor concerns about the company. Algonquin’s dividend yield in late January was 7.3 per cent, which is quite high.
Buying an entire sector via exchange-traded funds is often a strong alternative to picking individual stocks. But in the case of utilities, the ETF selection is overpriced. Both the BMO Equal Weight Utilities Index ETF (ZUT-T) and the iShares S&P/TSX Capped Utilities Index ETF (XUT-T) have management expense ratios of 0.61 per cent. That’s ridiculously high for this type of simple index-tracking fund.
Rob Carrick