The performance of the Utilities SPDR ETF (NYSE:XLU) is indicative of a huge bubble in utilities stocks, the likes of which we haven’t seen since the real estate bubble that nearly brought down our entire financial system.
Investment manager Michael Lebowitz recently pointed out that the utilities sector is now trading at three standard deviations above its long-term average:
— Michael Lebowitz (@michaellebowitz) August 4, 2016
These standard deviations, also known as “sigma,” are used to help assess how current valuations compare to past norms. Utilities’ position at 3 sigma is historic. From The Felder Report:
Jeremy Grantham defines a bubble as a 2 sigma event, which should occur every 44 years or so. This 3 sigma event in utilities is statistically the very same degree of overvaluation we witnessed in residential real estate at the height of its recent bubble and should only occur once every 1,200 years.
What’s causing utilities’ unnatural move higher? It’s simple: record low interest rates.
Fixed income investments like bonds, CDs, and the like have never offered lower yields. That means investors seeking (or in some cases, requiring) yield have been forced to look in riskier areas like stocks, junk bonds, and emerging market bonds.
Utility stocks have long offered market-beating yields because they have slow-growth businesses, are highly regulated, and many times enjoy a legal monopoly of their services. Typically, valuations in this sector tend to be very low compared with Technology, for example, which sees much faster growth.
No one knows what the fallout of these record valuations will be, because it’s literally never happened before.
The XLU fell $0.07 (-0.14%) to $50.66 per share in premarket trading Monday. The largest ETF targeting utilities stocks has gained 17% since the start of 2016, more than doubling the S&P 500’s 7% rise in the same period.