What happens when a safe-haven sector is no longer safe in your portfolio?
Well, if you had exposure to utility stocks over the past two months, you’ll notice they haven’t been safe at all.
By tracking the Utilities Select Sector SPDR ETF (NYSE: XLU), we can see those stocks have dropped more than 12% since mid-November.
This is at a time that the S&P 500 jumped more than 10% — quite a contrast to say the least.
The question now is, what happens next?
I’ll explain today why this sector looks primed to rally, and the best stock to use so you can benefit.
The Tax Reform Boost
First, let’s understand why there was a sell-off.
I mean, didn’t all corporations get a boost from tax reform?
These stocks pass on their earnings in the form of lower rates to consumers, so the company itself doesn’t see the direct benefit from slashing corporate taxes.
They also don’t benefit as interest rates rise due to the boost tax reform gives, meaning that utility stocks, which almost always have heavy debt loads, will have to pay more on that debt.
But there are benefits these companies will see later down the road, which is why I think the dip is a great opportunity to jump in.
Even though it doesn’t get the immediate benefits, lower rates for consumers gives a utility room to raise rates in the future to cover investments to upgrade and improve their operation.
Another benefit on the way has to do with depreciation of assets. Thanks to the new tax law, regulated utilities, like the one I’ll recommend today, are exempt from a cap on depreciation at 30% of operating cash flow.
These tax reform benefits will take time to make an impact, so that, along with rising rates, has helped spark the sell-off we saw in the sector.
But, at this point, I am going to respectfully disagree with my colleague and good friend, Ian Dyer. He makes several good points for the utility sector to continue its decline in a recent article, and that very well may be the case.
I see it as an overdone sell-off, though, and if the sector is going to not enter a bear market, this is the point I expect to see the bottom come in. That makes it an ideal time to add some exposure to the sector.
Of course, I always keep risks in mind, so if the overall sector dips back to $49.75 according to XLU, then I’ll give into Ian’s viewpoint on this one.
For now, I’m using the dip to add exposure to quality utility stocks like Duke Energy Corp. (NYSE: DUK).
Duke Energy Stock Is An Opportunity You Can’t Pass Up
Duke Energy, a Charlotte, North Carolina-based utility company, is an ideal way to play the dip in the sector.
It is one of the largest utilities in the world, with over 7 million customers spanning six states. But the reason I like the stock — other than being from my home state of North Carolina — is that more than 93% of its revenues come from regulated utilities.
This is the type of revenue that provides the steady and consistent streams of income, and it’s also the type of revenue that will see a slight benefit from tax reform.
While utility stocks, as I mentioned, won’t see these benefits for some time, they will still come — and Duke Energy will be on the receiving end of those.
Interest rates are another story to watch. But even if those creep higher, I think the current adjustment to these stocks is accounting for that.
That makes Duke Energy an opportunity I wouldn’t pass up today.
Chad Shoop, CMT
Editor, Automatic Profits Alert