With Interest Rate Cuts Commencing, the Utilities Rally Gathers Momentum
Jun. 11, 2024
The Bank of Canada (BoC) cut rates for the first time in four years on June 5, ending one of the most aggressive hiking cycles in Canadian history. Market expectations are for two additional cuts before the end of the year, with the next cut coming as early as July. Moreover, forecasters are predicting the BoC could potentially cut the overnight rate more than a full percentage by this time next year, to 3.5%, presenting more opportunity for the Utilities sector to rally.1
South of the border, rate expectations are falling as well, with the U.S. Federal Reserve (Fed) now expected to cut rates twice before the end 2024 with the first taking place in September.
Featured ETFs
Benefits
- Exposure to utility stocks that may benefit from declining interest rates
- Call option writing (ZWU) can reduce volatility and generate enhanced monthly income
- Professionally managed by BMO Global Asset Management portfolio managers
With the anticipation of further rate cuts from the BoC and the Fed, we may well see the Utilities sector continue to shine. Government bond yields tend to have an inverse relationship with Utilities (when interest rates drop, utility stock prices typically increase, and vice versa). This is mainly due to the costs involved with sector companies. The cost of construction for power plants, and the maintenance of infrastructure required to deliver gas, water, or electricity can make Utilities expensive when the cost of borrowing is high.
From a technical perspective, the BMO Equal Weight Utilities Index ETF (Ticker: ZUT) just broke out of a massive “double bottom” reversal pattern (see chart). The recent close above resistance at $20.60 completed the pattern, shifted the long-term trend to bullish, and opened an initial upside target that measures to $23.40. One of the key drivers for the turnaround in utility stocks as of late is a sharp decline in long-term interest rates. There is now a possibility of yields testing the lows of 2023 which could be a persistent tailwind for interest sensitive stocks and may push ZUT above an upside target of $23.40 at some point in the next 6-12 months.2
For the long-term investor, Utilities offer investors stable and consistent dividends over time, along with lower volatility. The long-term growth potential to deliver safe and reliable returns make the sector an attractive investment to consider adding to your portfolio. There are long-term benefits for Canadian investors, especially those who might consider the current environment as an opportunity to capture growth.
Utility ETFs
Name |
Ticker |
Management Fee |
Distribution Yield3 |
0.55% |
4.44% |
||
0.65% |
8.08% |
Bloomberg, May 31, 2024.
If you are looking to capitalize on the potential upside to the Utilities sector look to ZUT, an equal weight strategy that pays an attractive distribution yield of 4.44%.3 Equal weight can be an effective strategy for reducing concentrated risk by approximately weighting each stock equally across the ETF’s 15 holdings.5 Furthermore, the equal weight strategy can be a powerful index construction methodology, both to mitigate individual security concentration and properly diversify market capitalization exposure. The smaller companies within ZUT not only have the diversification support of the larger companies, but when the sector starts to pick up momentum, those companies have the potential of outperformance due to their cyclical nature.
For those looking to have attractive distribution yield and want to participate in the Utilities sector at a more cautious approach, ZWU has been one of BMO’s most popular covered call strategies, accumulating a total of $1.8 billion in AUM as of May 31, 2024.1 ZWU pays a distribution yield of 8.10%3 and when reinvested into the portfolio, can provide more cushion in downward markets. This ETF also has a diversified basket with an equal weight approach.5 Investors have the opportunity to capture cashflow and growth throughout North America as ZWU is diversified across Canada and the U.S. with 60% in Canada and 40% in the U.S.-listed stocks.1
Annualized Month End Returns as of May 31, 2024.4
Fund |
Ticker |
1-Month |
3-Month |
6-Month |
1-Year |
3-Year |
5-Year |
10-Year |
9.36% |
7.29% |
6.32% |
-7.49% |
-2.24% |
6.24% |
7.12% |
||
4.88% |
5.74% |
6.61% |
3.58% |
1.38% |
2.67% |
3.15% |
1 Bloomberg as of June 6, 2024.
2 Technical Indicators source: BMO Wealth Management June 6, 2024.
3 This yield is calculated by taking the most recent regular distribution, or expected distribution, (excluding additional year end distributions) annualized for frequency, divided by current NAV. The yield calculation does not include reinvested distributions.
4 Annualized Month End Returns source: Morningstar May 24, 2024.
5 Bloomberg holdings as of June 5, 2024.
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