Equities in the utilities space, typically seen as defensive plays and bond proxies given their high yields, have rallied this year for several reasons, but one driver in particular sticks out to Chad Morganlander, portfolio manager at Washington Crossing Advisors.
Mergers and acquisitions in the space, as well as deregulation, have propelled the sector (and a popular utilities-tracking exchange-traded fund, the XLU) to new heights this year, Morganlander pointed out.
But the most important factor is the direction of interest rates. Utilities stocks are particularly sensitive to rate shifts given their high yields relative to the rest of the market; he believes as interest rates will likely take a leg lower, utilities will likely fare well going forward.
Morganlander, who carries an overweight to neutral position on utilities, believes the "long end" of the yield curve, or the benchmark 10-year Treasury yield, will likely go lower and perhaps even hit 2 percent as economic growth appears to slow. If that occurs, utilities will "continue to have a bid underneath it" and find support.
Of course, "If that reverses and the long end of the yield curve starts to break down and interest rates go higher — that's called duration risk — you'll start to see utilities underperform. But for this point in time, for the next three months, we would still continue to be long utilities," Morganlander said Monday on CNBC's "Trading Nation."
From a technical standpoint, the picture is not as rosy, said Craig Johnson, chief market technician at Piper Jaffray. The firm carries an underweight position in utilities, and Johnson pointed to "bearish divergence" looking back on longer-term charts of the XLU. In other words, its price has gone up (and has even made a series of "higher highs and higher lows," Johnson pointed out) but the sector's relative performance to the broader market has, historically, disappointed.
"We think any sort of push to new highs here is probably going to be temporary, as we think about the longer-term aspects of the utilities sector," Johnson said Monday on "Trading Nation."
The sector is this year's third-best performer out of the S&P's 11 sectors.