Is This Time Different?

While the stock market has focused on technology stocks for the last few years, they comprise less than 1/3^rd of the index. That means 2/3^rd of the stock market is out there to make money on…

One of our favorite groups to invest in our career is one of the smallest – the “Utilities” group. This group makes up only slightly more than 2% of the index.

Despite being such a small percentage of the index, it has been a much more significant percentage of my money-making in the last 30 years.

Many of you are familiar with our FREE IDEA. That company is in the utility space, and since we shared it with our paid readers (February), it is +73%, and for our free subscribers (March), it is +35%.

You can read our report here as well as our two updates - first update, second update.

Several of the top-performing stocks in the S&P 500 year-to-date are utilities. Here is that table…

The third and fourth highest returning stocks (right after the AI leaders) are utilities – Vistra Corp. (NYSE: VST) and Constellation Energy Corporation (NYSE: CEG). The ninth best – NRG Energy Inc. (NYSE: NRG) – is also a utility.

Clearly, there is some money to be made in the group!

We were lucky early on in our career to be introduced to an excellent group of utility analysts. We met them when they worked at the historic brokerage firm Oppenheimer, but they then went on to run the utility group at Goldman Sachs.

They educated us on the group and showed us how the group could present some incredible risk vs reward opportunities.

What is interesting about the utility group is that there is not a lot to do most of the time.

Occasionally, however, there is a LOT to do…

Our FREE IDEA is an example of a utility that went bankrupt. This happens every couple of years, and we have participated in almost a dozen of these situations in the last thirty years. Every single one has been a home run!

These situations are what we would consider “one-off” opportunities. Most often, there are none of them. You take them when you can get them.

Occasionally, though, there is ANOTHER type of opportunity in the group. This is a much broader type of opportunity.

We have only seen it once in our career, and it has made investors (and ourselves) a ton of money. We may be seeing it again. This time, it is also a much BIGGER opportunity than the last time.

This opportunity is driven by the long-term nature of the “investment cycle” in the utility sector.

The sector is thought of as low volatility and highly regulated. Both statements are factual and reflect the structure of the industry.

We need stability in our power infrastructure to be able to power our economy and our lives. As a result, most of the infrastructure is put into a "monopoly" structure where the needed heavy investments are paid back as a fixed return set by regulators.

The problem is that this process could better ensure that the right amount of investment is made into that infrastructure.

In recent years, we have seen relative underinvestment in the utility infrastructure. This is across all areas, including generation (power plants), transmission (the electric "pipes" from the plants to your neighborhood), and distribution (the electric "pipes" from the curb to your home.)

Significant investments HAVE been made over the last few decades, but more is needed. This is a result mainly of our political process.

Two of the most considerable constraints have been the "NIMBY" syndrome and the environmental movement.

“NIMBY” stands for “not in my backyard” and represents the idea that most people don’t want a major power plant or transmission facility built near them. They don’t want any major infrastructure built around them or to live through the construction process.

The environmental movement has made it even more difficult. Hardcore environmentalists have not only been opposed to ANY new infrastructure that would facilitate electricity generated from fossil fuels but also nuclear.

This has impacted the building of new power plants and prevented the network necessary to move power from those power plants.

These two factors have meant that infrastructure builds could have been faster and easier.

These have now intersected with three other economic and technological developments.

First, we have seen the continued roll-out of electric vehicles. The number of EVs as a percentage of the total auto fleet is still small. They may not use gasoline, but they still need to get power from somewhere.

Second, we have also seen increased “re-shoring.” This is the movement of heavy industry back to the United States from abroad. This was begun in earnest under the Obama and Trump administrations but picked up massively post-COVID.

Finally – there is artificial intelligence. There are several aspects to the equation, but the power consumption of the processing power needed for AI is a multiple of what we use right now.

We are seeing emerging challenges with constraints on infrastructure growth and now accelerating demand.

We may see significant power blackout events across the United States in the following summer or two.

Let’s get back to the stock performance of the utilities.

There is an exchange-traded fund (ETF) that tracks the S&P 500 utility sector. It is called the “Utilities Select Sector SPDR Fund” or ticker “XLU.”

That index has 31 components, and here is a table showing the performance of each of them (and the full index) year-to-date…

This is a fascinating data set.

There are 31 components to the index, and only seven are positive for the year. It is just the three that we referenced before that are driving the index's performance.

If you look at the MEDIA stock in the index, it is down almost -7% compared to the total index, which is up nearly +11%.

Some traditional market analysts have pointed out that the XLU tends to perform well when we are in a dangerous situation and should be playing defense. It does poorly when we are in a strong market.

Their criticism has been that the stock market may not be as strong as it looks because of the robust performance of the XLU. Year to date, the XLU has been the third BEST performing index – right after the two technology sectors.

We think this is a bad read.

First, the reality is that most utilities are DOWN on the year. The way they should be acting in a strong bull market.

Only THREE stocks are driving the performance. Without those three stocks, the average would be -6.5%, the worst sector in the stock market. Even worse than real estate!

Second, we think we may also enter a new investment cycle into power infrastructure. This will help both power generators and regulated infrastructure companies.

The more they invest, the more they can earn. Historically, that has helped the stocks move higher.

After following this sector for three decades, we think we are about to enter one of the "once-every-twenty years" investment cycles, which means that for utility stocks – this time IS different!