By Investing.com — Wells Fargo analysts suggest that now is a good time for investors to consider selling into the recent rally in the utilities sector. The sector has been one of the top performers year-to-date through September 24, sharing the spotlight with high-growth sectors like information technology and communication services.
The rally in utilities, traditionally a defensive sector, reflects the unusual market dynamics driven by ongoing economic uncertainty and investor demand for stability.
However, Wells Fargo analysts believe the time has come to capitalize on these gains, citing multiple factors that point to a potential underperformance of utilities in the near future.
The primary reason behind this recommendation lies in the expected shift in macroeconomic conditions. Wells Fargo’s outlook anticipates a soft landing for the U.S. economy, with gradual growth resuming in the next 12 to 18 months.
As uncertainties regarding the Federal Reserve’s easing cycle and the upcoming presidential election dissipate, the broader market is expected to pivot towards growth-oriented sectors.
This transition would likely weaken the relative appeal of utilities, which typically thrive in more uncertain or recessionary environments due to their stable cash flows and dividends.
Another major headwind for the utilities sector is the forecasted persistence of relatively high interest rates. The Wells Fargo team foresees that even with the Fed’s recent cuts, rates will remain higher than in previous cycles, which could create a drag on the sector.
utilities are highly leveraged, making them sensitive to borrowing costs. Higher rates could increase their interest expenses, reducing profitability. Additionally, higher yields in the fixed-income market could attract investors away from utilities, which are traditionally seen as yield plays, thus intensifying the sector’s competition for capital.
Historical trends also support this outlook. According to Wells Fargo’s analysis, the utilities sector has often underperformed following the first Federal Reserve rate cut in an easing cycle, as well as after presidential elections.
The data shows that, since 1989, utilities have underperformed the broader S&P 500 Index in six out of eight post-election years and in five out of six cycles following the first Fed rate cut.
This underperformance is likely tied to investors’ rotation into more growth-centric and cyclical sectors during periods of economic recovery.
In light of these factors, Wells Fargo recommends reallocating capital from utilities into more growth-oriented, cyclical sectors. The sectors highlighted for their favorable outlooks include Energy, which the firm rates as “most favorable,” alongside communication services, financials, industrials, and materials.
These sectors are expected to benefit more from the resumption of economic growth and could offer investors better opportunities for capital appreciation in the current market environment.
This tactical guidance aligns with Wells Fargo’s broader investment strategy, which emphasizes positioning portfolios for the next phase of the economic cycle. Investors who have enjoyed the rally in utilities may find this a timely opportunity to rotate into sectors poised for better performance as the economic landscape shifts toward recovery.
