Why I'm Not Selling My Utility Stocks

...especially with risk of a recession and second Tech Wreck rising daily

The 180 utilities I’ve tracked the last 35 years have all announced Q1 earnings and updated guidance. Only one cut its earnings guidance for 2023—a natural gas utility that also produces gas. None trimmed the longer-term guidance that ultimately sets the tone for dividends and stock prices.

That’s a very solid result in light of 18 months of persistent high inflation and rising recession risk. And it’s despite the 500 basis point increase in the benchmark Federal Funds rate, which doubled short-term borrowing costs for many companies.

We may still see cuts this year for some electric, gas and water companies depending on how weather affects demand for their services. But these results are a clear sign America’s essential services companies are prepared for recession and very well positioned to stay on track with growth plans, balance sheets and dividends.

Nonetheless, utility stocks have weakened this spring. The Dow Jones Utility Average is now at a high single digit percentage loss for the year after being at a profit to start May. That compares with a sizeable run-up in the S&P 500. And it’s fair for investors to ask why the underperformance?

I see several reasons. First, artificial intelligence companies—or at least anything investors connect to AI—have sucked the oxygen out of the room when it comes to stocks.

The S&P 500’s gains are thanks to frenzied buying of a handful of big technology names. They’re led by Apple Inc (NSDQ: AAPL), which has become the Index’s largest-ever holding at over 7.5 percent and a nearly $3 trillion market capitalization.

Already decoupled from sustainable valuations, big tech stocks have gotten a second wind from the AI frenzy. And the poster child is NVIDIA (NSDQ: NVDA), up 172 percent and on the verge of a trillion dollar market cap at 48 times expected next 12 months earnings and 38 times sales.

Those are numbers eerily reminiscent of popular technology stocks in early 2000, just before the Great Tech Wreck. And the concentration of such stocks in the capitalization-weighted S&P 500 is the greatest in 40 years by some measures.

AI’s potential implications are vast for basically any business that uses data, for cost cutting potential alone. And with the global economy continuing to digitize to improve efficiency, there are potential applications in almost every industry.

On the other hand, AI hype is flowing fast and thick right now, just as it has for every technology in history that’s captured investors’ imagination. And as anyone who owned leading technology stocks in 2000-02 can attest, when a boom inflates enough the bust can be so severe that even stocks of the companies that eventually dominate as businesses take years to recover if ever.

For example, it took Microsoft Corp (NSDQ: MSFT) 15 years to regain its early 2000 trading range. Amazon.com (NSDQ: AMZN) needed 8 years. And Cisco Systems (NSDQ: CSCO) has never come close to its split adjusted 2000 high of around 80, despite trebling sales from dominating networking and now security.

That’s a pretty good reason for investors to be wary of AI hype and the stocks riding it higher now. But so long as it lasts, utilities aren’t likely to get much traction.

Reason two is dividend stocks are universally weak, as stock market investors have instead holed up in at least temporarily higher yielding cash. The benchmark Dow Jones Select Dividend Index, for example, is down more than -12 percent on the year, even including dividends—which is actually much worse than the DJUA.

Ironically, there is a definite AI angle for power and communications services providers. Mainly, any meaningful adoption will require a big increase in demand for electricity and 5G/fiber broadband spectrum. NVIDIA’s projection of what future demand will be for its products at data center owners like Equinix Inc (NSDQ: EQIX), for example, has no chance of happening without a big jump in demand for electricity and spectrum.

Nonetheless, at least at this point, investors aren’t viewing the connection as a compelling enough reason to buy or even hold high quality utility sector companies, especially when the overall appetite for equities is low.

Utilities have faced a threat from the culture war spreading to energy, putting their long-term investment plans under scrutiny and by extension to earnings and dividend growth guidance. Dominion Energy (NYSE: D), for example, was forced to temporarily suspend earnings growth guidance last year, mainly due to pushback on its investment plans in Virginia. And American Electric Power (NYSE: AEP) may face a similar reckoning in Texas this year regarding its wind and solar plans.

Even Dominion, however, has reached an accommodation, with Virginia’s new regulatory law allowing faster recovery of costs in an inflationary environment, while the utility rolls out wind, solar and possibly more nuclear generation. And other utilities including American Electric express confidence they’re still on the same page with regulators, w\hich is the essential element for staying on track with growth and investment plans.

Even spiking natural gas prices appear to be receding as a risk to regulatory relations, with prices just 25 to 30 percent of what they were a year ago. And many companies appear to have passed peak usage for the fuel. For example, Southern Company’s (NYSE: SO) now operating Vogtle Unit 3 nuclear plant operating and Unit 4 set for startup by early next year will put a big dent in its gas needs.

Utilities also caught a big break with the deal to raise the federal debt ceiling. Not only were the tax credits in the Inflation Reduction Act untouched. But the long-stalled but 94 percent completed Mountain Valley Pipeline will now bring cheap gas to utilities. And utility co-owners NextEra Energy (NYSE: NEE) at 30 percent, Consolidated Edison (NYSE: ED) and Altagas Ltd (TSX: ALA, OTC: ATGFF) at 10 percent each and RGC Resources (NSDQ: RGCO) at 1 percent will have an opportunity to cash out at a big profit.

In the aftermath of every market selloff, companies that stay strong on the inside recover quickly. That’s my forecast for best in class utilities, which remain well positioned to both weather near-term economic and regulatory headwinds and keep long-term earnings and dividend growth on track. And that’s why I’m comfortable sticking with my favorites, despite their spring selloff.