To combat the worst inflation in forty years, the Fed raised the fed funds rate from near 0% to 5.25% to 5.50% from February of 2022 to July of 2023.
For the next year-plus, they held it there, hoping that the economy would hold up while also tamping down on inflation.
But the interest rate narrative is changing, and the Fed took its first accommodative steps by cutting the fed funds rate by 50 basis points at the end of September.
Falling rates and anticipation of future declines have ignited utility stocks. The Utilities Select Sector SPDR Fund (XLU), a sector bellwether, has rallied 20.3% since the end of June and 32% since the end of February, compared to returns of 7.4% and 15.1% for the S&P 500 over the same periods respectively. Utilities have been the best-performing S&P sector year to date with a 28.7% return.
Is the utility stock rally over? I don’t think so. The sector underperformed the S&P by 34% in 2023, when the XLU returned -7% and the S&P was up 27%. In fact, XLU has significantly underperformed the market for the past five-year, three-year, and one-year periods. Many individual utility stocks are still trading well below the all-time high while the S&P hit a new high this week.
Utilities are the most bond-like stock sector with high yields and slow growth. The direction of stock prices often mimics that of the bond market. Over the last forty years of trading history during Fed cycles, only about half the bond rally has occurred by the first Fed rate cut. It’s also important to consider the current state of the market and economy.
There is increasing worry about a recession in the quarters ahead. Perhaps it’s overblown. We may indeed get a soft landing. But recession or not, the economy is most certainly at least slowing. Utilities have a long track record of market outperformance during slowing economies and recession because of the highly defensive nature of earnings. People still turn on the lights even if the economy stinks.
The market is near an all-time high while the economy is deteriorating. It is likely to be an environment of falling interest rates for the next two years. Falling interest rates and a slowing economy are the ideal backdrop for utility stock performance. And many of these stocks are still cheap with high yields and newfound momentum.
Here are two of the best.
The 2 Best Dividend Stocks for Low Rates
NextEra Energy, Inc. (NEE)
Yield: 2.4%
NextEra Energy (NEE) is the nation’s largest producer of renewable energy and the largest utility in the country. It should be in an ideal position to benefit going forward.
NEE has historically been a superstar performer for a utility. But it has stumbled in recent years as inflation and rising interest rates made utilities an out-of-favor sector. But things are changing fast. NEE has huge momentum and is up over 50% since the beginning of March. But the stock is still below the all-time high.
NEE isn’t just some boring, stodgy utility stock with the possible benefit of good timing. It has a long track record of not only vastly outperforming the utility sector, but the overall market as well. Prior to 2023, NEE total returns more than doubled those of the S&P 500 in the prior five- and ten-year periods.
How could a utility stock provide such returns? NextEra is not an ordinary utility.
NextEra Energy provides all the advantages of a defensive utility plus exposure to the fast-growing and highly sought-after alternative energy market. It’s the world’s largest utility. It’s a monster with about $26 billion in annual revenue and a $173 billion market capitalization. Earnings growth and stock returns have well exceeded what is normally expected of a utility.
NEE is two companies in one. It owns Florida Power and Light Company, which is one of the very best regulated utilities in the country, accounting for about 55% of revenues. It also owns NextEra Energy Resources, the world’s largest generator of renewable energy from wind and solar. It accounts for about 45% or earnings and provides a higher level of growth.
Investors love it because they get the safety and income of a utility and still get great growth and capital appreciation. It’s the best of both worlds. There is also a huge runway for growth projects. NextEra has deployed $50 to $55 billion in the last few years for growth expansions and acquisitions. It also has a large project backlog.
Since 2006, NextEra has grown earnings by an average annual rate of 8.4% and grown the dividend at an average rate of 9.8% per year. That propelled the market returns stated above. The company is targeting 10% earnings growth and 10% annual dividend growth through at least 2025. NextEra has a long track record of meeting or exceeding goals.
Brookfield Infrastructure Corporation (BIPC)
Yield: 3.7%
BIPC is stock representing shares in the same entity as the original Brookfield Infrastructure Partners (BIP), except that instead of a Master Limited Partnership BIPC is in the form of a regular corporation.
Bermuda-based Brookfield Infrastructure Corporation owns and operates infrastructure assets all over the world. The company focuses on high-quality, long-life properties that generate stable cash flows, have low maintenance expenses and are virtual monopolies with high barriers to entry.
Infrastructure is defined as the basic physical structures and facilities needed for the operation of a society or enterprise. It includes things like roads, power supplies and water facilities. Not only are these some of the most defensive and reliable income-generating assets on the planet but infrastructure is rapidly becoming a timelier and more popular subsector.
As one of the very few tested and tried hands, Brookfield is right there. It’s been successfully acquiring and managing these properties for more than a decade in a way that delivers for shareholders. Since its IPO in 2008, the original BIP has provided a total return of 821% (with dividends reinvested) compared to a return of 449% for the S&P 500 over the same period. And those returns came with considerably less risk and volatility than the overall market.
Brookfield operates a current portfolio of over 1,000 properties in more than 30 countries on five continents. The company operates four segments: Utilities (30%), Transport (30%), Midstream (30%) and Data (10%).
The dividend is rock solid with a low 70% payout ratio and a history of steady growth, The payout has grown by a CAGR (compound annual growth rate) of 10% per year since 2009 and the company is targeting 5% to 9% annual growth going forward.
While long-term performance has been great, this dividend-paying stock has struggled amid the high-interest-rate environment. It has returned -19% over 2022 and 2023, but this is a likely big beneficiary of the changing interest rate narrative, and it has momentum.