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Utilities Suffer But Offer Some Coronavirus Market Immunity

Utilities Suffer But Offer Some Coronavirus Market Immunity

(Bloomberg Opinion) -- Even the havens aren’t safe from the impact of the coronavirus, including that old stalwart, the utility sector.

A few weeks back, when going to a bar came with only the usual health warning, I wrote that utilities were trading at a big premium to a stock market that was just starting to get nervous. That made some sense; utilities are a traditional refuge after all. But this refuge was priced more like a mansion. Moreover, it didn’t offer much shelter from the storm.

Utilities Suffer But Offer Some Coronavirus Market Immunity

Despite that, utilities’ premium to the S&P 500 — as measured on forward price/earnings multiples — has risen to more than 21%, the highest in almost seven years. That’s a slippery measure in the midst of a crisis, though, as forward estimates for many S&P sectors are in flux.

The more useful metric for utilities is the relationship of their dividend yields to interest rates and debt markets. Utilities’ regulated earnings and high payouts mean they are often treated as bond proxies, and their yields typically have a close relationship with corporate bond yields. A few weeks ago, I noted one danger for the sector was that fear would spread to investment grade bonds, causing spreads to widen out, pulling utility yields with them. And that’s what happened.

Utilities Suffer But Offer Some Coronavirus Market Immunity

While it’s dangerous to make any hard or fast predictions in this climate, there are good reasons to expect utilities to perform relatively better in the near term. The spread between utility yields and the bond index stood at about 74 basis points at Friday’s close (the latest reading for the index), tighter than the 10-year average of 118 points. That suggests there is some room for utilities to decouple even if anxiety levels remain high in bond land.

And this is an overwhelmingly domestic sector that is largely insulated from virus-related economic dislocation, both because power and gas demand aren’t likely to be impacted too much (except for some industrial plants). Most importantly, utilities earn a regulated return on their assets. The sector displays a comforting lack of correlation with GDP growth over the long term.

Even as S&P earnings continue to drop, those of utilities should remain relatively steady. That in itself should narrow the premium on that metric. Looking further ahead, when virus fears abate and some semblance of calm returns, it is likely the more beaten-down sectors directly affected by everyone staying home will outperform as they recover. For this strangest of times, though, poles and wires still look like a decent place to hide out.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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