Sectors To Watch: Who Pulled The Plug On Utility Stocks?

| August 27, 2012 | 0 Comments

Utility StocksDividend paying stocks have been the hottest area of the market lately.

And for good reason…

Economic growth is sputtering and interest rates are next to nothing.  Investors who want to earn a decent return on their investment see high quality dividend paying stocks as their best option. 

You see, high quality dividend paying stocks like utilities, consumer staples, telecoms, and health care are right in the sweet spot for many investors.  They’re stable enough to be seen as a safe investment and their dividend yield beats the heck out of anything you can get from Treasuries.

Just a few weeks ago, the Utilities Select Sector SPDR (XLU) was at a 52-week high.  It was up more than 23% from the 52-week low and riding a wave of optimism.  Now, the sector has given back a good chunk of those gains. 

Utilities Select Sector SPDR Chart

Over the last week, XLU has fallen 3%.  That’s a major selloff for a safe haven sector like utilities.  What’s behind the reversal of fortunes?

At first glance, utilities stocks are stable businesses with guaranteed demand for their product.  But behind the scenes, the last few years have been highly chaotic.

The utilities sector has been awash in a tidal wave of mergers and acquisitions.  The M&A activity has allowed the sector to reduce costs and increase profitability.

In fact, a good portion of the price gains we’ve seen in XLU over the last few years can be attributed to the cost reducing benefits of the M&A activity.   

But here’s the thing…  M&A activity is slowing down.

In the first quarter of 2011, there were 32 deals worth $53 billion.  But this year there were only seven deals greater than $50 million in the first quarter.  And they totaled just $4.1 billion.

In short, utility companies are having a hard time gaining government approval for their proposed mergers.  Unfortunately, the new hard line approach is likely here to stay.

And without the catalyst of M&A activity to propel XLU higher, this sector ETF is headed for a rough patch.  Take a look at buying the December $36 Puts for about $1 to profit from further downside in this sector in the second half of the year.

Good Investing,

Corey Williams

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Category: Sectors To Watch

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.