One of the most common questions we have been asked in our 40-plus years of utilities investing is “What will happen to utility stocks in a rising rate, inflationary environment?”
That question is certainly valid today given the most recently reported inflation figure of 7.9% and the U.S. 10-year Treasury Note yielding close to 2.5% for the first time since 2019. Inflation has not reached this level since 1981, which is why we believe looking back is relevant in assessing how utility stocks might perform in the current period of high inflation and rising interest rates.
In the 10-year period from 1973 to 1982, the annual inflation rate averaged 8.7% and the yield on the 10-year U.S. Treasury Note increased from 6.2% to 13.0%. Many might be surprised to see that utilities performed well during this difficult macro environment and outpaced inflation.
Table 1.
Year |
Inflation Rate (CPI)* |
Dow Jones Utility Average** |
1973 |
6.2% |
-19.9% |
1974 |
11.1% |
-15.3% |
1975 |
9.1% |
32.9% |
1976 |
5.7% |
40.2% |
1977 |
6.5% |
10.5% |
1978 |
7.6% |
-4.0% |
1979 |
11.3% |
18.5% |
1980 |
13.5% |
17.8% |
1981 |
10.3% |
5.7% |
1982 |
6.1% |
22.2% |
AVERAGE |
8.7% |
10.9% |
Source: U.S. Bureau of Labor Statistics (CPI); Bloomberg (DJ Utility Average)
*CPI = Consumer Price Index; data represents the annual rate of increase in the Index.
**Dow Jones Utility Average is used in this table as data for the S&P 500 Utilities Index was not available for these time periods.
Performance shown includes reinvestment of dividends.
More recently, we are encouraged by the relative strength of the utilities sector over the past two quarters as inflation and interest rates have moved to the forefront of many investors’ minds. The chart below highlights how year over year CPI has continued to rise over the past two quarters after exceeding the 6% level in October of last year. Over the same period, utilities are the second-best performing sector in the S&P 500 Index.
Table 2.
Time Period |
Inflation Rate (CPI)* |
S&P 500 Utilities Index |
| Q1 2022** | 7.7% | 2.5% |
| Q4 2021 | 6.7% | 12.9% |
Source: U.S. Bureau of Labor Statistics (CPI); Bloomberg (S&P 500 Utilities Index)
*CPI = Consumer Price Index; data represents the average annual rate of increase in the Index during the quarter.
**CPI data for Q1 2022 is the average for January and February; March data has not yet been reported.
The performance of the S&P 500 Utilities Index for Q1 2022 is for the period from 12/31/21 to 3/25/22 and includes the reinvestment of dividends.
In several previous blogs, we have stressed our view that utilities deserve consideration as an alternative to bonds given that bond yields are still relatively low on a historical basis and well below the current level of inflation. In addition, if interest rates should continue to rise, the total return from bonds in the next few years has the potential to be negative. In contrast, the underlying fundamentals of the utility sector, based on our analysis, are strong and we expect continued growth in earnings and dividends for many companies in the sector.
Since 2000, as shown in Table 3, utilities have outperformed bonds, on average, in the eight quarters in which the yield on the U.S. 10-Year Treasury Note moved higher by 50 basis points or more.
Table 3.
Time |
Change in Yield of U.S. 10-Year Treasury Note(basis points) |
S&P 500 |
Bloomberg |
| Q1 2022* | 96 | 2.5% | -6.9% |
| Q1 2021 | 81 | 2.8% | -3.4% |
| Q4 2016 | 85 | 0.1% | -3.0% |
| Q2 2013 | 65 | -2.7% | -2.3% |
| Q4 2010 | 77 | 1.1% | -1.3% |
| Q2 2009 | 82 | 10.2% | 1.8% |
| Q2 2008 | 54 | 8.0% | -1.0% |
| Q2 2004 | 76 | -1.3% | -2.4% |
AVERAGE |
77 |
2.6% |
-2.2% |
Source: U.S. Federal Reserve (10-year UST yields); Bloomberg (S&P 500 Utilities Index & Bloomberg U.S. Aggregate Bond Index)
*Data for Q1 2022 is for the period from 12/31/21 to 3/25/22 and includes reinvestment of dividends.
Explaining how and why utility stocks have managed to generate attractive returns during previous periods of sustained inflation and/or rising rates, we believe, is due to the growth of their dividends. The Reaves investment team has traditionally favored utilities with the ability to grow their earnings and dividends at an above average rate. Based on the guidance provided on recent earnings calls, we think that dividend growth for most utility companies can be maintained or increased over the next several years.
It is our view that elevated inflation and rising interest rates are not reasons for utilities investors to panic. We think it is more important to focus on the sector’s unique defensive characteristics and ability to consistently grow dividends and earnings Unlike bonds, which distribute a fixed rate of income to investors, the potential for a growing stream of income from well-managed utility stocks offers the potential for returns that can outpace inflation.
