Blackrock's (NYSE: BLK ) global chief investment strategist has bad news for utilities investors. In his latest weekly commentary, the investor pointed out a flaw in the "safe haven" stock plan that could leave this sector's market cap bloated for years to come. Here's what you need to know.
Managing director Russ Koesterich noted this week that the recent economic upturn has put many defensive stocks in a catch-22. Stock markets have been on a tear in 2013, with both the S&P 500 (SNPINDEX: ^GSPC ) and the Dow Jones Industrial up 16%.
But as Koesterich explains, there's one major difference in this season's soaring stocks:
Typically, when stocks advance dramatically it is a sign of increased risk appetite on the part of investors. In other words, when stock markets climb rapidly, higher-risk asset classes are usually outperforming. While we are seeing some signs of this (high yield, for example, has been performing well), many higher-risk investments such as commodities and emerging markets equities have actually been performing quite poorly. In the current rally, investors are favoring assets that are typically seen as "safe havens".
Koesterich is talking about utilities. These economic stalwarts are supposed to be slow movers, but investors' risk-averse appetites have pushed shares just as high as the S&P 500 in recent months.
The Dow Jones U.S. Utilities Index is up 14.4%, with Ameren (NYSE: AEE ) and Exelon (NYSE: EXC ) exceeding the industry average. Both utilities offer above-average stability to investors looking to get in on sustainable growth and big dividends.
With Ameren's exit from the merchant generation business, its operations (and income) will be highly regulated with some of the steadiest income around. Although Exelon operates in both competitive and regulated sectors, the company's massive 19,000 MW nuclear fleet offers investors an opportunity to own 20% of U.S. nuclear power, a consistent and increasingly cost competitive energy source.
But regardless of stable revenue, Koesterich has a point. Along with Ameren's and Exelon's soaring shares, their valuation has gotten increasingly expensive. As a rough analysis, Ameren's price to tangible book value is up 20.5% to 1.47, while Exelon's value has shot up 22.3% to 1.63.
Can this sector survive?
Anyone analyzing gains this year would be wise to question utilties' rapid rise, but a more long-term review adds a pinch of perspective to pricing. Ameren is still down 20% from pre-recession highs, while Exelon stock's jump leaves it 60% below its 2009 value.
Here at the Fool, we don't look to past prices to predict future ones, and we don't play the macro game to figure out which sector will soar as Mr. Market shifts his weight around. In every sector, there are excellent companies with fair prices, and in the long run these corporations will succeed.
A bull market means investors need to be all the wiser allocating investments, but the best companies, utilities or otherwise, will continue to reward investors for years to come.
As the nation moves increasingly toward clean energy, Exelon is perfectly positioned to capitalize on having the largest nuclear fleet in North America. This strength, combined with an increased focus on balance sheet health and its recent merger with Constellation, places Exelon and its resized dividend on a short list of the top utilities. To determine if Exelon is a good long-term fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for instant access.