Is Now a Good Time to Sell? Utilities Rally, According to Wells Fargo

Wells Fargo analysts are advising investors to consider selling during the recent rally in the utilities sector. This sector has been one of the strongest performers year-to-date through September 24, along with high-growth areas such as information technology and communication services.

The recent strength in utilities, typically viewed as a defensive sector, highlights the unique market conditions driven by ongoing economic uncertainty and a desire for stability among investors. However, the analysts at Wells Fargo believe it’s time to take advantage of these gains, pointing to several reasons that suggest utilities may underperform in the near future.

One major factor behind this recommendation is the expected change in macroeconomic conditions. The firm anticipates a soft landing for the U.S. economy, with gradual growth projected to resume within the next 12 to 18 months. As uncertainties regarding the Federal Reserve’s easing cycle and the upcoming presidential election become clearer, the broader market is likely to shift focus toward growth-oriented sectors. This shift could diminish the relative attractiveness of utilities, which typically perform well in uncertain or recessionary times due to their stable cash flows and dividends.

Additionally, the utilities sector may face challenges from the forecasted continuation of relatively high interest rates. Despite recent Federal Reserve cuts, analysts expect rates to remain higher than in past cycles, which could negatively impact the sector. Given that utilities are generally highly leveraged and sensitive to borrowing costs, increased interest expenses could hamper profitability. Furthermore, higher yields in the fixed-income market may entice investors away from utilities, which are traditionally favored for their yield.

Historical data supports this outlook. According to Wells Fargo’s analysis, utilities have often lagged behind the broader market following the first Federal Reserve rate cut in an easing cycle and after presidential elections. Since 1989, the utilities sector has underperformed the S&P 500 Index in six out of eight post-election years and five out of six cycles after the first Fed rate cut. This trend is likely linked to investor rotations into more growth-oriented and cyclical sectors during periods of economic recovery.

Given these insights, Wells Fargo recommends reallocating investments from utilities to more growth-oriented, cyclical sectors. They highlight Energy as the most favorable sector, along with communication services, financials, industrials, and materials, all of which are expected to thrive as the economy grows and could provide better opportunities for capital appreciation in the current market climate.

This strategic advice aligns with Wells Fargo’s broader investment philosophy, which focuses on preparing portfolios for the upcoming phase of the economic cycle. Investors who have benefited from the utilities rally might find it prudent to pivot into sectors that are likely to perform better as the economy shifts toward recovery.