Key Takeaways
- The United States (and the world) is gradually shifting from a petro-state to an electro-state, which could provide a long-term tailwind for utilities.
- The sector saw strong relative performance in 2022 for its defensive characteristics.
- Your clients may continue to favor defensive stocks in 2023 given the current confluence of economic headwinds.
- Electric utilities that are moving toward decarbonization could be particular beneficiaries of the shift to renewables.
For 2023, the outlook for the utilities sector is strong.
The sector's defensive characteristics could continue to look attractive to investors seeking shelter during market and economic choppiness. But the long-term growth story is perhaps even more compelling: The United States (and the world) is gradually shifting from a petro-state to an electro-state. Utilities are poised to be primary beneficiaries of that shift.
Coming off a (relatively) strong year
The year 2022 brought an about-face in market leadership, which benefited utilities. The sector came into the year relatively undervalued—particularly in comparison to high-flying technology and growth segments that performed so well during the market's pandemic surge.
But as causes for macroeconomic angst started to pile up at the start of the year—from inflation, to interest-rate hikes, to geopolitical conflict—investors began favoring securities with more defensive qualities. Utilities are one of the most defensive parts of the economy, because households and businesses by and large keep the lights on even when the economy is in its darkest hour. By mid-year, utilities had gone from being among the weakest-performing sectors in the S&P 500® to ranking among the strongest.
Source: Past performance is no guarantee of future results. Utilities sector performance is represented by the S&P Utilities Select Sector index. Data as of Dec. 9, 2022. Source: S&P Dow Jones Indices, a division of S&P Global.
A boost from new legislation
The past year also brought a legislative win for the utilities sector. In August, President Biden signed the Inflation Reduction Act into law. Among other initiatives, the act aims to put the United States on a path to substantially reduce greenhouse gases and make clean-energy options more accessible and affordable to consumers and businesses.
The legislation includes tax subsidies intended to lower the costs of renewable energy, which should help keep customer rates low. In short, the legislation is expected to accelerate the transition away from fossil fuels to renewable resources for energy generation within the United States—hastening that move from petro-economy to electro-economy.
Utilities could remain in favor
As we look to 2023, the economy and markets may continue to face the onslaught of headwinds they've encountered this year—including rising interest rates, persistently high inflation, political unrest, and slowing growth worldwide. Amid this environment, utilities could remain in favor for their defensive characteristics, which include durable cash flows and dividends.
But again, the long-term story could be even more compelling. Utilities are at the epicenter of the transition to renewable energy sources. Generating power from renewable resources is now more economical than generating power from fossil fuels, thanks to technology improvements and increased economies of scale among renewables. Meanwhile, consumers, businesses, and governments are actively seeking to reduce their carbon footprints. These primary factors are propelling accelerated earnings growth for utilities, with average earnings growth in the sector recently rising to its highest levels in decades.
Potential beneficiaries
As this energy transition continues, companies that are investing to expand their renewable-energy fleets could benefit.
There could also be advantages for companies focused on nuclear energy, as nuclear could be a beneficiary of the Inflation Reduction Act and help bridge the energy gap as generation from renewables ramps up.
Positive backdrop
As the United States and countries worldwide march toward carbon neutrality, the utilities sector is at the center of the energy-generation transition from fossil fuels to renewables. The combination of a challenging economic environment and long-term tailwinds from the shift to renewables provides an optimistic backdrop for performance in the utilities sector.