Shares of NextEra Energy (NEE -1.38%), its yieldco NextEra Energy Partners (NEP -1.11%), Brookfield Renewable (BEPC -0.88%), and Brookfield Infrastructure Partners (BIP -1.85%) were surging in today's trading, up 2.7%, 6.7%, 6%, and 7.5%, respectively, as of 3 p.m. ET.
All of these companies are either utilities or utility-like equities that have similar qualities to bonds: high dividend payouts, recurring revenue, and are often financed with a healthy amount of debt. NextEra is a utility and power project developer, which often sells renewable projects to NextEra Energy Partners, which in turn pays a high dividend to unitholders.
Meanwhile, Brookfield Renewable and Brookfield Infrastructure are also yield-oriented equities that buy and sell various types of infrastructure assets. Brookfield Renewable owns hydroelectric, wind, and solar projects. Brookfield Infrastructure owns other critical infrastructure assets in electricity distribution, pipelines, railways, ports, highways, natural gas storage, telecom towers and fiberoptic lines, semiconductor manufacturing facilities, and data centers.
While Brookfield Infrastructure surged yesterday following its better-than-expected third-quarter report, the common denominator across all four of these stocks today has to do with interest rates. Today, long-term interest rates took a dive after a labor and productivity report from the Department of Labor.
What does one labor report have to do with renewable utilities?
Today, long-term bond yields as defined by the 10-year Treasury bond rate were in decline, falling over 11 basis points as of 3 p.m. to 4.676%, and significantly down from the recent high near 5%.
Why were long-term bonds down? First, 10-year bond yields have been relentlessly on the rise of late, from the low-3% range earlier this year to near 5% last month. Therefore, many may think the move has gone too far, with buyers now stepping in.
Also, long-term inflation expectations have a lot to do with it. One of the most important factors behind the persistent inflation in services has been labor costs and productivity. This was due to a greater and longer-than-expected shortage of workers following the pandemic, combined with "revenge" spending on experiences and services in the aftermath.
But today's labor report could be a tipping point. Unit costs for labor actually fell 0.8% in the third quarter. That was significantly lower than the expectations of positive unit labor costs of 0.7%. Unit labor costs are now up just 1.9% over the past year, below the Fed's 2% inflation target.
Of note, that doesn't mean overall labor costs actually fell. In fact, wages rose on average 3.9%. However, that was countered by a stunning 4.7% rise in productivity, which is a measurement of output per worker, as output rose 5.9% even though hours worked only rose 1.1%.
An increase in labor productivity could mean inflation may come down without the economy entering a recession. Although other data out on Thursday, such as initial filings for unemployment and continuing jobless claims, did come in slightly higher than expected, those numbers are still relatively low by historical standards.
Whether due to companies cutting fat or improvements from automation and possibly artificial intelligence, lower unit labor costs should go a long way in bringing down services inflation, which has been the stickiest part of the post-pandemic inflation surge.
That could mean the Federal Reserve is done hiking interest rates, and that investors may accept lower yields for long-duration assets.
Lower "risk-free" rates help bonds and bond-like instruments. It could be especially beneficial to NextEra and NextEra Partners. NEP is a yieldco, which means it has to constantly tap the capital markets to acquire assets from NextEra Energy and continue raising its dividend. But as we've seen recently, if rates surge and the stock of NEP plunges, it can get too low to sell equity. Thus, the business model can become "stuck," and NextEra may not be able to drop down projects at reasonable prices.
The only way for the model to work, then, is if NEP becomes unstuck. And lower interest rates may be the only way out of that conundrum.
If the economy slips into recession, utilities may be a good bet
While all stocks would benefit if interest rates go down in a vacuum, many stocks might not if that happens in conjunction with a hard economic downturn. However, these infrastructure stocks will probably hold up better in a down economy, as they often operate on fixed and recurring long-term take-or-pay contracts.
As we've seen over the past year, however, even recession-resistant stocks aren't immune from interest rate risk. But if interest rates are now topping out, these leaders in the space may be good defensive plays -- especially for investors worried about a potential recession.