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By Andrew Vachon, BMO Global Asset Management
The Bank of Canada (BoC) cut rates on June 5th for the first time after one of the most aggressive hiking cycles in Canadian history.
Market expectations from the BoC indicate that we may see 2 to 3 more cuts before the end of the year with the second cut potentially as early as July and the remaining later in the year.
South of the border, inflation has remained “stickier” however; the market expects the U.S. Federal Reserve (the Fed) to cut rates twice before the end of the year with the first beginning in September. Moreover, forecasters are predicting the BoC could potentially cut the overnight rate from the current rate of 4.75% all the way down to 3.5% by this time next year, presenting more opportunity for the Utilities sector. 1
With the anticipation of further rate cuts from the BoC and the Fed we may see the Utilities sector shine. Government bond yields tend to have an inverse relationship with utilities (when interest rates drop, utility stock prices typically increase, and vice versa). This is mainly due to the costs involved with these companies. The cost of construction for power plants, and the maintenance of infrastructure required to deliver gas, water, or electricity can make utilities expensive when the cost of borrowing is high.
From a technical perspective, the BMO Equal Weight Utilities Index ETF (Ticker: ZUT) just broke out of a massive “double bottom” reversal pattern this week. A double bottom pattern is a classic technical analysis charting formation showing a major change in trend from a prior down move. The recent close above resistance at $20.60 completed the pattern, shifted the long-term trend to bullish, and opened an initial upside target that measures to $23.40.
One of the key drivers for the turnaround in utility stocks as of late is a sharp decline in long-term interest rates. There is now a possibility of yields testing the lows of 2023, which could be a persistent tailwind for interest rate sensitive sectors of all stripes and perhaps push this Utility ETF above the initial upside target of $23.40 at some point in the next 6-12 months. 2
Yielding the Benefits
For the long-term investor, Utilities offer investors stable and consistent dividends over time along with lower volatility. The long-term growth potential to deliver safe and reliable returns, make the sector an attractive investment to consider adding to your portfolio. Utilities overall have remained fundamentally strong as they provide basic services such as gas, water, electricity and telecommunications that will always be in demand regardless of where we are in the economic cycle.
There are long-term benefits for Canadian investors, especially those who might consider the current environment as an opportunity to capture growth.
Furthermore, the long-term goal of moving toward clean and renewable energy sources from 7 of the world’s most advanced economies (G7) bodes well for the Utility sector. Renewable energy continues to grow, and governments nationwide have increased their focus to reduce greenhouse gases and make clean energy options more accessible.
As technology continues to improve, generating power from renewable energy sources has become more economical than traditional fossil fuels. Many analysts believe solar energy will be one of the fastest growing technologies over the next 10 years. 6 Even with political uncertainty, many believe there will still be a focus on clean energy and as countries worldwide move toward decarbonization. The Utilities sector remains at the center of the transition from fossil fuels to renewables.
Your gateway to Utilities exposure: BMO’s Utilities ETFs
If you are looking to capitalize on the potential upside to the Utilities sector look to the BMO Equal Weight Utilities Index ETF (Ticker: ZUT) . ZUT is an equal-weight strategy that pays an attractive distribution yield of 4.38%.3 Equal Weight can be an effective strategy for reducing concentrated risk by approximately weighting each stock equally across the ETF’s 15 holdings. 5 Furthermore, the equal weight strategy can be a powerful index construction methodology both to mitigate individual security concentration and properly diversify market capitalization exposure. The smaller companies within ZUT not only have the diversification support of the larger companies, but when the sector starts to pick up momentum, those companies have the potential of outperformance due to their cyclical nature.
For those looking to have attractive distribution yield and want to participate in the Utilities sector through a more cautious approach, the BMO Covered Call Utilities ETF (Ticker: ZWU) has been one of BMO’s most popular covered call strategies, accumulating a total of $1.8 billion in AUM as of May 31st 2024. 1
ZWU pays a distribution yield of 8.09%3and when reinvested into the portfolio can provide a cushion in downward markets. This ETF has a diversified basket of 78 holdings with an equal weight approach. 5 Investors have the opportunity to capture cashflow and growth throughout North America as ZWU is diversified across Canada and U.S. with 60% in Canada and 40% in the U.S. 1
For investors who would like to take advantage of the Clean Energy theme, BMO Clean Energy Index ETF (Ticker: ZCLN) not only invests in clean energy companies globally, but also invests in companies that are involved in clean energy businesses. Renewables play an important role in our future. Whether that be solar, wind, geothermal or hydro these carbon neutral options have unlimited supply and will help create a cleaner, healthier society.
Countries around the globe are investing heavily in green energy development including areas like clean transportation, energy efficiency, deployment, and R&D which is having a great impact on job growth and emissions reductions. Climate change remains a hot topic in the political landscape.
Andrew Vachon has over 15+ years of industry experience and has spent the last 7 years growing BMO Global Asset Management’s suite of Separately Managed Accounts, Mutual Funds and ETFs. Andrew has been a guest on ETF Market Insights broadcasts and Interactive Brokers delivering ETF education to end investors. His primary focus is ETF product development and strategy at BMO ETFs by engaging stock exchanges, capital markets desks, index providers, and portfolio managers to bring new ETFs to market. Andrew has his Chartered Investment Management designation with the Canadian Securities Institute.
1 Bloomberg as of June 6th 2024.
2 Technical Indicators Source: BMO Wealth Management June 6th 2024
3 ZUT Annualized distribution Yield of 4.38% as of June 7, 2024. Annualized Performance NAV of 1Y -7.49%, 2Y -8.30%, 3Y -2.24%, 5Y 6.24%, 10Y 7.12% and Since Inception 6.68%. ZWU Annualized distribution Yield of 8.09% as of June 7, 2024. Annualized Performance NAV of 1Y 3.58%, 2Y -4.47%, 3Y 1.38%, 5Y 2.67%, 10Y 3.15% and Since Inception 4.10%. This yield is calculated by taking the most recent regular distribution, or expected distribution, (excluding additional year end distributions) annualized for frequency, divided by current NAV. The yield calculation does not include reinvested distributions.
4 Annualized Month End Returns source Morningstar May 24th 2024
5 Bloomberg holdings as of June 5th 2024
6 Morningstar May 31st 2024
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