I know everyone loves the idea of decent yield at a time when rates are so low and Fed rate cut dreams have given them another boost, but the Utilities sector is overdone at this point. I have been giving DOWN signals on some of these stocks during 2007 and that has not worked out as well as I had hoped. Still, the technicals and fundamentals keep telling me to look for any opportunity to exit UP signals. Having this low growth sector as a leader of S&P performance is not encouraging to me. High profile buyout premiums like TXU have certainly fueled this rally but the investor love affair with yield chasing has been the bigger factor.

Along the way, prices have risen so high that the yield on utilities are right around historical lows of about 2.8% versus 6.3% at the start of the bull run. The last time the yield on the S&P 500 Utilities Index was lower than today occurred in 2000 but no one seems to care that you can get a much higher yield in a money market account. The utilities index has risen about 13% this year and since past bear market ended in October 2002, they have advanced almost twice as much as the S&P 500. Lovers of utilities will point out that total returns are a function of capital appreciation as well as dividends. I get that, but there comes a point when that story is more about the past than the future. We are at that point.

I pulled up the valuation metrics I used last April and compared them to today’s numbers on the same 90 utility stocks covered by HEDGEfolios. The average PE(TTM) was 18.5 last year and it’s 26.7 now. The average forward PE was 16.6 last year and now it’s 23.6. At a significant premium to the the S&P 500, Utilities are richly valued and as previously mentioned, dividend yields have declined dramatically. Were investors so wrong about valuations back then or are they more wrong now?

One of the most dangerous portfolio management scenarios is focusing on returns while ignoring risk and I see that in abundance with utilities and frankly, most yield plays whether that is mortgage-backed securities, junk bonds, REITs, etc. Investors have been told for eons that stocks like utilities are defensive plays because the high yield will serve them well during periods of slow growth. However, that usually occurs after a period where Utility stocks were out of favor and that is not the case in the current environment. You cannot avoid risk for this long and not have to deal with repercussions down the line. As the old saying goes…”I’d rather be out wishing I was in, than in wishing I was out.”