To The Moon

With the long-term US Treasury bond yields falling to their lowest level in three months, US long-term bond ETFs have seen a unilateral rise. ETFs such as $iShares 20+ Year Treasury Bond ETF(TLT)$ $Direxion Daily 20+ Year Treasury Bull 3X Shares(TMF)$ $ProShares UltraShort 20+ Year Treasury(TBT)$ $ProShares Ultra 20+ Year Treasury(UBT)$ $Direxion Daily 20 Year Plus Treasury Bear 3x Shares(TMV)$ that offer leveraged long and short positions on US bond indexes, have all presented significant opportunities.

In addition to direct investments in US Treasury bonds, ETFs such as $Utilities Select Sector SPDR Fund(XLU)$ which tracks the utility sector index, have also surged due to their defensive nature and higher dividend yields. Investors have anticipated a slowdown in the labor market and easing inflation based on current economic data, leading to expectations of interest rate cuts.

While XLU has been under pressure in the technology sector due to the high interest rate environment earlier this year, it has rebounded by about 12% since its low point in October, narrowing its year-to-date losses to less than 10%. In terms of dividend yield, XLU has the highest average, second only to the $Financial Select Sector SPDR Fund(XLF)$

Why are utility ETFs attractive now?

Firstly, there is a favorable macro environment. With US bond yields expected to continue declining over the next year, utility stocks typically perform well in a low interest rate and economic recessionary environment. Utilities provide essential services such as electricity, water, and natural gas, which are necessary for individuals and businesses regardless of the economic climate. This constant demand ensures stable revenue streams for utility companies, making them less susceptible to economic downturns. Compared to the earnings of technology companies, the demand for utility services tends to remain relatively stable during economic recessions, which can experience significant volatility.

Secondly, during periods of declining interest rates, income-seeking investors often turn to utilities due to their high and stable dividend yields. As the yields of fixed-income securities such as bonds decrease with falling interest rates, utilities become more attractive due to their ability to provide stable income streams, driving up their stock prices and outperforming other industries in the stock market.

Thirdly, utilities are capital-intensive businesses that typically finance their infrastructure investments through capital raising. In a environment of declining interest rates, borrowing costs decrease, and stock valuations usually rise, making it easier for utilities to finance their operations and expansion projects. This lower cost of capital not only improves their profit margins but also allows them to invest in more growth opportunities.

Lastly, the current valuation is relatively attractive and has the potential for valuation recovery after experiencing a decline in 2023. Due to rising interest rates, XLU has fallen by about 20% in the past 15 months, and changes in interest rates could significantly increase the valuation multiple of XLU, driving strong total return performance. In addition, this means that resistance from higher interest rates has already been fully priced into utility stocks, which means that even if interest rates remain at higher levels in the long term, the downside risk is not significant compared to more favorable macro factors.

Choosing an ETF instead of an individual stock is due to low cost and diversification. XLU holds a total of 31 utility companies, with its positions mainly composed of blue-chip stocks. XLU has very low management fees, as it only has a low expense ratio of 0.10%, with assets under management of nearly $14 billion and ample liquidity.