Dragosits and the portfolio management team at Harvest conducted studies of past interest rate rising cycles to inform their view on utilities. They look at eight different rate hiking cycles, with soft and hard landings. Across every example, whether the economy fell into recession or not, the transitional period when rates hit their peak was positive for the utilities sector. Even if rates stay higher for longer, hitting peak rates should be enough to drive some positive performance for the sector.
The question now arises as to whether we’re headed for a hard or soft landing in the US and Canadian economies. Dragosits says as of now it’s too early to tell which way things will go. The historical analysis his team conducted, however, can give us some pointers as to how that might play out in utilities.
Dragosits identified two instances of soft landings following interest rate hikes: 1984 and 1995. After posting positive returns during the transitional period, the utilities sector posted positive returns. However, the sector tended to underperform the broader S&P 500 as other growth trends drove overall market valuations.
Far more interest rate hiking cycles ended in a hard landing. Harvest ETFs studied 1979, 1980, 1989, 2000, 2006, and 2019 for their examples. Across those examples utilities were again positive during the peak/transition period. When the hard landing hit the utilities sector’s performance turned negative. However, against a backdrop of overall falling equity markets during a recession, utilities actually outperformed the S&P 500 across all of those hard landing scenarios. Dragosits notes that, typically, investors add utilities positions for defensiveness, so outperforming a falling market — even if sector returns are themselves negative — may mean a utilities position is doing exactly what it was intended to do.
As advisors consider their utilities exposure, Dragosits argues that a basket of positions may be better suited to modern market conditions than a single utility stock. He notes that the ETF he manages, HUTL, holds global exposure to Canadian, US, and European utilities as well as subsector diversification that includes traditional utilities like energy as well as telecoms.
