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2 Graphs Utilities and Telecom Share Investors Need to See

By Alex Dumortier, CFA – Jul 12, 2016 at 2:39PM

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As bond yields collapse, investors are piling into utilities and telecoms stocks, but reaching for yield at any price is hardly a riskless strategy.

Image source: Getty Images.

Done! It took us 418 days to get there, but stocks finally put in a new high yesterday, with the benchmark S&P 500 (^GSPC -0.16%) closing at 2,137.16. Despite yesterday's effort, traders have enough energy (animal spirits, really) to continue pushing stocks higher today. The S&P 500 and the Dow Jones Industrial Average (^DJI 0.01%) (DJINDICES: $INDU) were up 0.82% and 0.76%, respectively, at 2:25 p.m. EDT.

2 graphs utilities and telecom share investors need to see

As this column pointed out yesterday, it's ironic that this new milestone should occur on the same day the second-quarter earnings season officially gets under way (aluminum provider Alcoa Inc fired the starter's pistol with its earnings report after yesterday's close). Indeed, current earnings estimates for the S&P 500 provide little support for higher stock valuations.

But with the incredible shrinking bond yield(s), who has the luxury of worrying about such details? As the pangs of yield hunger become more intense -- with no end to their starvation diet in sight -- investors are choosing to pay up for a ticket to the dividend yield banquet.

Naturally, the stocks that resemble bonds most closely are the ones that are the most attractive to yield tourists. These stocks offer an above-market yield and are less volatile, both in terms of their business performance and stock price (most of the time, at any rate). The two sectors that best exemplify those characteristics are telecoms services and utilities.

The result is clear for all to see. The following graph shows the relative performance of the Vangard Utilities ETF and the Vangard Telecommunication Services ETF:

VPU Total Return Price Chart

VPU Total Return Price data by YCharts.

However, this new-found yield banquet is entirely not risk-free. As investors push the prices of these shares up, the dividend yield decreases and, more importantly, so does the margin of safety in the share price. When price increases eat the margin of safety up entirely, or worse still, push it into negative territory (i.e., the stock price exceeds its intrinsic value), investors face genuine risk -- above-market yield notwithstanding.

For proof, just looks at investors' earlier experience with two sets of stocks they thought they could substitute for bonds, master limited partnerships (MLPs), and mortgage REITs:

^SPXTR Chart

^SPXTR data by YCharts.

That's genuine equity volatility right there, folks -- nothing to do with bonds. Note that both sectors have substantially underperformed the S&P 500 over the past five years. A rich yield is nice -- but not at the expense at your principal value. Investors piling into utilities and telecoms stocks right now ought to keep that lesson in mind.

Tweet of the Day

NASDAQ now within 1% of where it was on March 10, 2000.
When you say "stocks for the long run" remember to stress that word "loooooooong"

— Jason Zweig (@jasonzweigwsj) July 12, 2016

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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