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Amid intensifying tensions in the Middle East, the utility sector, which has become investors' new hot spot this year, continued its solid rally. This is especially true as the sector, being considered as defensive, is making the most of the widening crisis and the Fed rate cuts. No wonder most utility stocks and ETFs are hitting fresh highs. 

Reaves Utilities ETF (UTES - Free Report) has emerged as the biggest winner, climbing 47.3% this year. It was followed by gains of 31% each for Utilities Select Sector SPDR (XLU - Free Report) , Vanguard Utilities ETF (VPU - Free Report) , Fidelity MSCI Utilities Index ETF (FUTY - Free Report) and iShares U.S. Utilities ETF (IDU - Free Report) . These ETFs, hitting a series of new one-year highs in the recent trading sessions, carry a Zacks ETF Rank #3 (Hold) each.

Here, we discuss some strong reasons for the outperformance of the sector and ETFs. These factors are likely to fuel the rally in the coming weeks as well:

Defensive Investment

Being a low-beta sector, utility is relatively protected from large swings (ups and downs) in the stock market and is thus considered a defensive investment or safe haven amid economic or political turmoil.

Iran launched about 200 ballistic missiles targeting Israel on Oct. 1, leading to growing fears of retaliation from Israel. The attack has accelerated tensions in the Middle East region. If the conflict accelerates further, it will disrupt global energy shipments and, thus, economic growth.

Dovish Fed

Being interest rate-sensitive, utility stocks got a boost from the rate cuts. After holding the rates at a 23-year high for 14 consecutive months since July 2023, Federal Reserve Chair Jerome Powell kicked off the new rate cycle era by initiating a 50-basis point cut in interest rates. This marked the first rate cut since 2020. 

The central bank projects two more rate cuts of 50 bps in its final two meetings this year, due in November and December. It also indicates another 100-bps rate cut next year and a 50-bps cut in 2026, which means four rate cuts in 2025 and two in 2026. 

As utilities require huge infrastructure, which creates a massive debt burden and interest obligation, the Fed’s loosening policy is a tailwind for the sector.

AI Boom

AI is bolstering the demand for electricity, as data centers require tons of energy for computing and cooling power. A simple ChatGPT task uses 10 times the energy a normal Google search does. So, data centers with a capacity of 30 megawatts are boosting capacity to handle 300 megawatts of power. This has made the traditional defensive sector of the market most appealing. The Energy Information Administration says data centers are “one of the most energy-intensive building types, consuming 10 to 50 times the energy per floor space of a typical commercial office building”.

Solid Industry Fundamentals

The sector continues to benefit from an ever-increasing population, which is pushing up demand for utility supplies like water, gas and electricity. The increased adoption of electric vehicles will also boost electricity demand for companies within the utilities sector.

ETFs in Focus

Reaves Utilities ETF (UTES) – 52-Week High: $66.06

Reaves Utilities ETF is the only actively managed ETF that seeks to provide returns through a combination of capital appreciation and income, primarily through investments in utility stocks. It holds 17 stocks with a heavy concentration on the top three firms. UTES has AUM of $192.1 million and trades in an average daily volume of 46,000 shares. It charges 49 bps in annual fees.

Utilities Select Sector SPDR (XLU) – 52-Week High: $82.06

With an AUM of $18.3 billion, Utilities Select Sector SPDR seeks to provide exposure to companies from the electric utility, water utility, multi-utility, independent power and renewable electricity producers, and gas utility industries. XLU follows the Utilities Select Sector Index, holding 31 stocks in its basket. Electric utilities take the top spot among sectors at 65.5%, closely followed by multi utilities (25.7%). Utilities Select Sector SPDR charges 9 bps of annual fees and sees a heavy volume of 10.6 million shares, on average. 

Vanguard Utilities ETF (VPU) – 52-Week High: $176.35

Vanguard Utilities ETF follows the MSCI US Investable Market Utilities 25/50 Index, holding 66 securities in its basket. More than half of the portfolio is allocated to electric utilities, closely followed by multi utilities (24.9%). Vanguard Utilities ETF charges 10 bps in annual fees and sees a good volume of around 192,000 shares on average. It has AUM of $6.7 billion.

Fidelity MSCI Utilities Index ETF (FUTY) – 52-Week High: $52.55

Fidelity MSCI Utilities Index ETF provides exposure to 69 utility stocks with AUM of $1.4 billion. This is done by tracking the MSCI USA IMI Utilities Index. Here too, electric utilities and multi utilities are the top two sectors with 62.7% and 24.4% share, respectively. Fidelity MSCI Utilities Index ETF has an expense ratio of 0.08%, while the average daily volume is good at 200,000 shares a day.

iShares U.S. Utilities ETF (IDU) – 52-Week High: $103.41

iShares U.S. Utilities ETF tracks the Russell 1000 Utilities RIC 22.5/45 Capped Index. It holds a basket of 44 securities. Here again, electric utilities dominate the portfolio at 58.1%, followed by multi utilities (22.3%).iShares U.S. Utilities ETF has amassed $1.5 billion in its asset base while trading in a good volume of 128,000 shares a day on average. The fund charges 39 bps in annual fees.

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