Most Americans look at the Dow Jones Industrials (DJINDICES:^DJI) as their primary gauge of stock market performance, and corrections of even just 10% have been hard to come by in recent years. Yet you don't have to look far to find another Dow average that is already in correction territory, having fallen more than 10% from its high just a few short months ago. The weakest link in the Dow chain is the Dow Jones Utilities (DJINDICES:^DJU), and many investors believe utility stocks will continue to underperform the rest of the market.
Why utilities have lost their appeal
During most of the bull market, the Dow Utilities rose just like the Industrials did. The Utilities Average more than doubled from its 2009 lows, and on a total return basis it performed even better because of the high yields among most of its 15 component stocks.
Yet since late January, the Utilities have plunged. Southern Co. (NYSE:SO) has led the way lower with a 16% drop, but more than half of the stocks in the average have fallen by over 10%.
A host of factors are punishing utilities right now. The biggest has to do with the macroeconomic environment. The high debt levels most utilities carry make them sensitive to interest rates, and fears of rate hikes from the Federal Reserve have sent their stocks falling in lockstep with bond prices recently.
At the same time, utilities' business models are being fundamentally transformed. The days of simply firing up coal-powered generating plants have largely disappeared, as environmental regulation requires utilities to be more conscious of the impacts of pollution in generating electricity. The rise in renewable energy has starting eating into growth prospects for utilities; in particular, solar power has highlighted the costs of maintaining a grid in the midst of reversed energy flows at peak solar-generation times even as net-metering laws and other provisions prevent utilities from passing those costs on to customers with solar power systems or other renewable energy sources.
Until recently, high dividend yields have been the saving grace for utility stocks, as dividend investors have gravitated to the industry. With prospects apparently fading, though, dividend investors are thinking twice before locking themselves into stocks with apparently high yields but accompanying concerns about their ability to sustain current levels of revenue and profits -- let alone grow them.
As many look for a Dow correction, the Dow Utilities are already in the middle of one. Whether that spreads to the Industrials remains to be seen, but the utility pullback proves stocks don't just move in one direction forever.