Utility Stocks & Interest Rates

Discussion in 'Trading' started by drobin, May 15, 2005.

  1. drobin


    An investment manager recently informed me that when interest rates rise or are expected to rise utility stocks become good trading vehicles. Any views on this claim?
  2. nitro


    Be careful, the dividend in these utilities are tied to profits, not just the interest rate outlook.

    For example, in the winter of 2000, natural gas spiked above $8 per thousand cubic feet, producing a rally in natural gas and electric utilities. Most power plants are powered by natural gas, and as the price of power rises, so do utilities' profits.

    You also need to see if the utility you are investing in is cheaper or more expensive than say a market index, like the SP500. For example, electric utilities typically carry a P-E 35% lower than the S&P 500. And electric utilities pay average dividends of 4.5%. But you need to see where the spread is historically against a typical market index, not just the absolute difference.

    Also consider this, GE trades alot like a utility! :eek: Since utilities have little or no growth, if you also want some market exposure, would you consider going long GE instead?

    You also need to consider whether the utility is regulated or not, lest you get into an Enronesque situation. However, unregulated utilities can be more profitable...

    You have to also consider what the supply and demand curve for what the utility is producing. If you haven't done so thus far, put up a chart of the CRB index.

    In short, interest rates are but one component (albeit an important one but that can be said of ANYTHING in the markets) of the pricing of utilities.

  3. drobin


    Nitro, thanks for the info, it's greatly appreciated.:cool:
  4. In 2003 most power plants in the U.S. used coal to generate electricity; nuclear fuel ranked second and natural gas third.


    Also, rising power costs do not necessarily translate to higher profits for electric utilities. In fact, due to regulatory lag, rising costs will often cause profits to decline.

    Historically, there doesn't appear to be a strong correlation between utility stocks (a term that includes electric and natural gas utilities) and interest rates. Utility stocks moved higher in the 1970's while interest rates were soaring ... and they moved higher in the 1980's and 1990's while rates were falling. The only period of significant movement downward for utilities occurred along with the bursting of the equity bubble in 2000 - 2002, a result of too many utilities venturing into non-utility activities.

    The essence of Nitro's statements hold true: there are too many variables to conclude an interest rate movement of X will produce a utility stock movement of Y. In fact, there have been times when the popular adage was rising rates would lead to falling utility stock prices, because utilities were viewed as interest rate sensitive due to large amounts of debt outstanding.
  5. drobin


    QQQshort thanks. Nitro gave me the cake & you've given me the cream. Greatly appreciate the info. :)