Trader Talk

Utilities sinking; is it Rotation Time?

Paula Bronstein | Bloomberg | Getty Images

Utilities and defensive names: is the party over? Utilities are again melting down as Treasury yields rise. The Dow Jones utilities index is down another 2 percent midday after dropping 2.5 percent Wednesday.

What's up? A sudden rise in the 10-year yield yesterday, which is continuing today, is the likely culprit. We went from 1.73 percent to Thursday's 1.87 percent on the 10-year note in 24 hours.

The opposite happened, though over a longer period, in February. As Treasury bond yields dropped in February on recession fears, investors dumped massive amounts of money into Utility ETFs and other defensive sectors like consumer staples.

Suddenly, boring old Utilities like Duke, Southern and Dominion got plenty of attention, not least because they were sporting dividend yields of between 4 percent and 5 percent.

The prices also rose. The Dow utilities index rose almost 10 percent in February and March, as did select consumer staples like Colgate, which rose in January and February as the broader market declined.

The result: valuations rose rapidly. Many of the big utility names are trading at 17 to 18 times forward earnings, well above their traditional range of 15 to 16 times. Colgate is at almost 25 times forward earnings!

Then there's the final piece of sector-specific news for Utilities: earnings. Electric and gas utilities are beginning to report, and analysts I have spoken with have indicated that the warm winter didn't help any of them.

You can see this in the report today of Unitil Corporation, an electricity distributor that operates in New England. They reported much lower energy usage for heating related purposes due to the unusually warm weather; the stock is trading down over 8 percent Thursday.

Bottom line: with utilities, you have a combination of 1) warm weather hurting earnings, 2) high valuations, and, most importantly, 3) a move up in interest rates, which are causing yield-hungry investors with itchy fingers to pull the trigger and get out early.

Finally, with about one-fifth of the S&P 500 reporting earnings, you can throw in a growing realization that the earnings guidance in general is somewhat more positive than expected. Bingo. Rotation time!

OK, we are not there yet. They are getting out of defensive names without piling into cyclicals. But watch this space for signs of moves into the cyclicals like industrials, materials, and consumer discretionary.