Penn Wealth Publishing

2016.01.10 Journal of Wealth & Success Vol 4 Issue 1.1

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Page 9 of 21

Buy utilities, now? investment intelligence 10 wealth & success volume 4 issue 1 January 10, 2016 Copyright 2016. All Rights Reserved. In a rising rate environment, why are we adding utilities to our portfolio? Utilities. The grand old dame of the investment universe. If you had a wise grandparent who liked to impart their stock picking prowess on anyone who would listen, they probably told you to put your money in safe, secure utility stocks. To be sure, as interest rates were bleed- ing down to zero, income investors had to search for yield where they could get it. Utilities were generally the first tranche that got filled up, based on the high aver- age yields and lower general risk of the main players in the industry. And that made sense. After all, as Eugene and Gladys Crosspatch witnessed their monthly investment income stream dwindling down due to called bonds and bare-bones rates, what safer place to turn than the gas and electric companies that provide power to their house? But what happens to utility stocks when interest rates rise? In theory, it would make sense that fixed-income investors would begin to dump them and move back into "safer" bond vehicles when yields began to look decent again. To study this theory, we examined the 2004 to 2006 timespan, when the Fed moved to raise interest rates a copious 16 times. Take a look at the accompanying graph, which compares the US Target Fed Funds Rate to the basket of major utility names in the Utilities Select Sector SPDR® Fund, an ETF we have used many times in the past, and also one of the most liquid util- ity investments available. Surprisingly, the two are highly correlated over that time frame. So, despite the fact that investors had stronger fixed options available, they also continued to invest in utilities. The correlation begins to drop off a bit when the Fed Funds Rate hit 3.75, but con- sidering we just went from zero to 25 bps, that is probably a long way off. After a strong 2014, utilities have been lackluster, to say the least, in 2015—off about 12% year to date. Much of this has been due to the market paranoia sur- rounding the Fed's rate liftoff. Based on the balance sheets of the top tier com- panies, however, these stocks have been unduly punished. Valuations are reason- able, and the yields remain stable. Investors tend to forget that the Fed's decisions only affect short-term rates, but utilities take their cue from longer-term bonds. Considering the amount of risk an investor would be taking on with a 30-year Treasury bond yielding under 3% (that will get crushed when rates start to pick up steam), utilities make a lot more sense to own right now. On the following page we outline our latest utilities acquisition inside of the Dynamic Growth Strategy. Our portfolio weighting for the sector is currently 5-7%, which we will monitor as rates go higher.

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