Share this story
Close X
Switch to Desktop Site

Utility issues sizzle while industrials waffle

For about two months now the Dow Jones industrial average has behaved like a stymied mountain climber just short of a summit. After a successful fair-weather hike in August, the stock market has been alternately coaxed and discouraged by the economic outlook. First, there are forecasts of clearing interest rates or a partly sunny economy. So the Dow eagerly seizes the opportunity to race up to the 1,240 level. Then, the clouds of uncertainty return and the market winds its way back down to its base camp at 1,200.

This past week, the Dow industrials (comprising 30 stocks designed to represent the nation's industrial mix), after reaching its base camp, was once again retracing a well-worn path upward. It closed on Friday at 1,206.71, up 4. 97 points for the week.

About these ads

There is another mountaineer on Wall Street, however, that has had more success of late. Electric utility stocks are on the move. In fact, since July they've been climbing and in September the ascent of the Dow utilities index was rather steep.

Several utilities have already hit their 52-week highs. Reflecting their strength, the utility index closed this past week at its highest level since last November, and the September run-up hasn't been matched since January of 1983.

Why are investors snapping up utilities now?

Well, it's no coincidence that interest rates are coming down. For the last two weeks, Wall Street has been coming to the conclusion that all the reserves the Federal Reserve has been pumping into the banking system are an earnest effort to bring interest rates down. Last week, acting on this assumption, many of the major banks lowered their prime rate to 121/2 or 123/4 percent.

The utility buying binge is ''basically an interest-rate play,'' says Mark D. Luftig, chief utility and telecommunications analyst at Salomon Brothers Inc., a New York brokerage house. ''A number of people think long-term rates are coming down.''

The result of this thinking has been a surging bond market. As fixed-income security prices rise and yields drop, utilities look much more competitive. ''And portfolio managers tend to prefer equity to debt,'' Mr. Luftig notes.

Although interest rates are important, Arlene Barnes, vice-president and electric utility analyst at First Boston Corporation, lists four other factors influencing utility stock resurgence:

About these ads

* A growing awareness that the financial fundamentals (less capital spending, better cash flow and earnings) of these companies have been turning around.

* Market prices have not kept pace with earnings improvements of the last four years.

* Some issues are actually being viewed as less sensitive to interest rates as the underlying companies finish up heavy construction projects and are now being perceived as countercyclical.

* Investors are becoming more comfortable with the nuclear risk.

As several companies incurred cost overruns and cut or omitted dividends, a dichotomy emerged between the stock performance of nuclear and nonnuclear utilities last fall. Nuclear stocks plummeted, while nonnuclears fell moderately.

''When the nuclear 'crisis' arose in the fourth quarter of '83, people looked at utilities and saw a whole slew of stocks that could get into trouble. Now the gap between the yields is narrowing a bit,'' Ms. Barnes says.

So far, the nonnuclears have benefited the most from this latest buying spree. But ''now the stocks that aren't involved in plant construction are selling above book value and their yields have dropped to single digits,'' says Luftig at Salomon Brothers. ''This indicates to me that they're near their top (prices).

''I think the action will come next in the nukes - the utilities with completed nukes or ones that are just coming on line.'' Yields on these stocks are currently between 11 and 12 percent.

In June, Luftig said utilities would rise for the next six months. He still holds that opinion but hasn't looked much beyond the year end. Ms. Barnes at First Boston ventures, ''The general trend in utility stocks is up over the next two years.''

When asked if the Dow utility index presaged a move in Dow industrials, neither analyst felt there was a strong tie-in.

''There is a much better correlation between bond rates and utility stocks than (between utilities and) the Dow industrials,'' says Luftig. And Barnes warns that the Dow utility index is not the best for following electrics, saying , ''It includes four gas pipeline companies that tend to move opposite to the electric utilities.''

Getting back to our determined highland hiker, the Dow industrial, what is the outlook here?

Ricky Harrington, a technical analyst at Interstate Securities, in Charlotte, N.C., says: ''I see some signs of selling pressure over the next few weeks. There have been so few issues carrying the market - mostly autos and technology stocks. Meanwhile the underlying mass of stocks have not been as strong as the Dow.''

So in the near term, Mr. Harrington thinks the Dow will regroup and set up a new base camp at about the 1,160 or 1,180 mark.

Interest rates Percent Prime rate 12.50-12.75 Discount rate 9.00 Federal funds 11.00 3-Mo. Treasury bills 10.60 6-Mo. Treasury bills 11.05 7-Yr. Treasury notes 12.48 30-Yr. Treasury bonds 12.24

Source: Bank of Boston, other banks

Follow Stories Like This
Get the Monitor stories you care about delivered to your inbox.