Do Utilities Still Have More Room to Run?
Sep. 4, 2024
With the Bank of Canada (BoC) cutting rates for the third time this year, the market consensus is for rate cuts to continue over the course of the remaining meetings in 2024, bringing the overnight rate down to 3.75%. Economists have forecast additional cuts to borrowing costs through next year, as well, with the current easing cycle bringing rates to a terminal level of approximately 2.25-2.50% by the end of 2025.
South of the border, similar to Canada, the market views current rates in the U.S. as being very restrictive. At the Jackson Hole Economic Symposium, Federal Reserve Chairman Jerome Powell gave clear signals that the central bank will cut its interest rate at the September meeting. Expectations are for the Federal Open Market Committee (FOMC) to cut rates by as much as 100 basis points (bps) before the end of 2024. With only three meetings left, this could mean an outsized cut of 50 bps at one of these meetings. Moreover, forecasters are anticipating weaker U.S. economic data going forward (especially the labour market) and we are thus likely to see further cuts into 2025 with a U.S. terminal rate sitting around 3%.
ETFs in Focus
Key Benefits
- Designed for investors looking for growth and income solutions in Canadian and U.S. utilities sectors
- Diversification to lessen security specific risk within the Utilities sector
- BMO’s covered call strategy can reduce volatility through call option writing
With the anticipation of further rate cuts from central banks, we could potentially see the Utilities sector continue to do well. Government bond yields tend to have an inverse relationship with utilities (when interest rates drop, utility stock prices typically increase, and vice versa).1 This is mainly due to the costs involved with sector companies. The cost of construction for power plants, and the maintenance of infrastructure required to deliver gas, water, or electricity can make utilities expensive when the cost of borrowing is high.
For the S&P/TSX Utilities index, we have seen a breakout from a “double bottom” reversal pattern, where the index closed at 2,456 and completed the pattern (see chart). This was important from a technical analysis point of view in that this breakout shifted the long-term price trend back to bullish and opened an initial upside target that measures to 2,800 — presenting a great opportunity for the sector.2
Yields across the curve have fallen substantially over the last several months due to market expectations of future rate cuts, leaving investors looking for other yield options. For the long-term investor, utilities offer investors stable and consistent dividends over time, along with low volatility. Moreover, the long-term growth potential to deliver safe and reliable returns makes this defensive sector an attractive investment to consider adding to portfolios. There are potential long-term benefits for Canadian investors, especially those who might consider the current environment as an opportunity to capture growth.
Utility ETFs
Name |
Ticker |
Management Fee |
Distribution Yield3 |
0.55% |
4.27% |
||
0.65% |
7.75% |
Bloomberg August 23, 2024.
If you are looking to capitalize on the potential upside to the Utilities sector look to the BMO Equal Weight Utilities Index ETF (Ticker: ZUT). ZUT is an equal weight strategy that pays an attractive distribution yield of 4.27%.3 Equal weight can be an effective strategy for reducing concentrated risk by approximately weighting each stock equally across the ETF’s 15 holdings.3 Furthermore, the equal weight strategy can be a powerful index construction methodology, both to mitigate individual security concentration and properly diversify market capitalization exposure. The smaller companies within ZUT not only have the diversification support of the larger companies, but when the sector starts to pick up momentum, those companies have the potential of outperformance due to their cyclical nature.
For those looking to have attractive distribution yield and want to participate in the Utilities sector at a more cautious approach, the BMO Covered Call Utilities ETF (Ticker: ZWU) has been one of BMO’s most popular covered call strategies, accumulating a total of $1.9 billion in AUM.4 ZWU pays a distribution yield of 7.75%3 and when reinvested into the portfolio can provide more cushion in downward markets. This ETF has a diversified basket of 65 holdings with an equal weight approach.4 Investors have the opportunity to capture cashflow and growth throughout North America as ZWU is diversified across Canada and U.S. with 60% in Canada and 40% in the U.S.4
Annualized Daily Returns as of August 27, 20245
Fund Name |
Ticker |
YTD |
3-Month |
6-Month |
1-Year |
3-Year |
5-Year |
10-Year |
7.25% |
5.26% |
13.71% |
4.02% |
-2.35% |
6.71% |
7.19% |
||
10.43% |
6.61% |
11.92% |
13.86% |
1.77% |
3.36% |
3.28% |
Annualized Month End Returns as of July 31 20245
Fund |
Ticker |
YTD |
3- Month |
6- Month |
1-Year |
3-Year |
5- Year |
10- Year |
5.61% |
13.45% |
8.32% |
-0.47% |
-3.28% |
6.50% |
7.46% |
||
8.27% |
8.71% |
8.04% |
8.32% |
1.33% |
3.30% |
3.33% |
1 Utility companies are capital-intensive, relying heavily on borrowing to finance growth, infrastructure upgrades, and maintenance. As borrowing costs decrease, utilities benefit from lower expenses, making them more attractive investments during periods of monetary easing. In addition, their dividends are often seen as competing with bonds for investor dollars, and they could appear attractive amid falling rates.
2 Technical Indicators Source: BMO Wealth Management August 23, 2024.
3 This yield is calculated by taking the most recent regular distribution, or expected distribution, (excluding additional year end distributions) annualized for frequency, divided by current NAV. The yield calculation does not include reinvested distributions.
4 Bloomberg holdings as of August 23, 2024.
5 Annualized Month-End and Daily Returns source Morningstar.
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