Many investors ask themselves the most questions when their portfolio is performing solidly mixed. As a result, we thought the first part of this piece, which was originally featured in Conrad’s Utility Investor, was apt for all our readers, including those of Capitalist Times. We also include thoughts on what’s happening in the high yield space, also from CUI, given investor enthusiasm for such names in recent weeks. If you aren’t reading Conrad’s Utility Investor now but are invested in utilities, consider subscribing.
Finding the confidence to stick with underperforming holdings comes from understanding the companies’ underlying business, monitoring their health in quarterly results and attending industry conferences to talk to management teams and institutional investors.
In November 2016, my annual pilgrimage to the Edison Electric Institute’s financial conference confirmed my view that the industry is poised to benefit from several growth opportunities in coming years. (See Inside Man: Roger Conrad’s Best Ideas from the Edison Electric Institute’s 2016 Financial Conference.)
My top five picks from the conference have rallied an average of 11.6 percent in the intervening months, beating the Dow Jones Utility Average’s 6.9 percent return over the same period.
This outperformance stands in stark contrast to the conventional wisdom that rising interest rates and the incoming Trump administration’s policies could be a negative for utilities’ earnings and stock prices.
Elevated valuations, however, remain a concern. And from a technical standpoint, the Dow Jones Utility Average has yet to break out of the downtrend that started in early July.
With these factors in mind, we’ll stick with the three-part strategy we’ve followed for much of the past year:
Yield has topped growth this year for several reasons. Recovering energy prices since mid-February and improving economic data in the back half of 2016 have encouraged investors to take on more risk. The same goes for the stock market’s upward momentum, which picked up following the November election.
In the energy sector, higher-yielding fare benefited from the absolute beating that these stocks absorbed in fall 2015 and early 2016.
From its peak in September 2014 to its trough in February 2016, the Alerian MLP Index gave up 47 percent of its value. Energy Transfer Partners’ (NYSE: ETP) stock plummeted 62 percent over this period, while growth-oriented name Dominion Midstream Partners LP (NYSE: DM) gained 24.8 percent.
Although yield moths who flocked to Ferrrellgas Partners LP’s (NYSE: FGP) double-digit yield suffered an 80 percent distribution cut and lost almost 60 percent of their principal, the higher-yielding stocks in our Utility Report Card generally posted solid returns this year.
This risk-on trade could carry into the first few months of 2017, as President-elect Donald Trump and Congressional Republicans have pledged to cut taxes and roll back federal regulation.
This expectation, coupled with the Federal Reserve’s recent rate hike and plans to increase interest rates three more times next year, has catalyzed a stampede out of Treasury bonds, tightened the market for corporate debt and strengthened the US dollar. All these developments should embolden investors to take on additional risk.
At the same time, the S&P 500 continues to trade at elevated valuations, levels that usually precede a significant selloff. Markets can remain irrational much longer than investors can remain solvent; stocks don’t necessarily pull back when valuation multiples reach these levels. However, a higher bar of expectations increases the risk of disappointment.
An acceleration in US economic growth could help to shore up shaky dividends, though higher interest rates eventually take a toll on companies that have taken on excessive leverage, especially if their underlying business starts to falter.
In light of this year’s underperformance and concerns about rising interest rates, we expect names that offer superior dividend growth to do better in 2017. Investors’ ardor for high-yielding fare could also cool next year.