What were the worst performing sectors of the S&P 500?
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What were the worst performing sectors of the S&P 500?

The Utility Sector

In 2012 the two worst performing sectors of the S&P 500 Index were utilities and energy with both sectors underperforming the index by over 10 percent.  With the S&P 500 obtaining a total return of approximately 13 percent in 2012, underperformance by the utility sector was not too surprising.  This is because the utility sector is viewed as consisting of companies that provide basic essentials that are largely immune to the ebbs and flows of the overall economy.  With this belief the utility sector is thought to underperform during bull markets and outperform during bear markets.  Yet, perhaps the utility sector’s relative performance with the energy sector can offer some clues to the underlying demand within the industry.   

For the distribution portion of utilities, this area is still regulated in the traditional manner.  Because of the lack of competition for most utility companies in local areas, regulators determine the rate at which companies can charge their customers.  As a result distribution revenues typically increase at a steady rate.  With relatively steady demand from local customers causing a lack of fluctuation of revenues, utilities are seen as safe haven stocks during downturns.  

However, companies that generate power from oil, natural gas, coal, and nuclear energy and then supply it to distributors operate in a competitive market.  Following the deregulation of this part of the utility sector in the late 1990s, these unregulated utilities began to trade more like oil and gas companies.  Wholesale electricity prices (the prices at which generators sell their fuel to retailers) are based on the marginal cost of the energy that is used to supply the last bit of demand in the industry.  Frequently, this energy is natural gas.  As a result this typically means higher profits for operators of low-costing coal and nuclear power plants when oil and natural gas increase – and vice versa.

The Energy Information Administration is forecasting that electricity use in the U.S. will rise an average of 0.6 percent per year for industrial users and 0.7 percent for households through 2040.   In comparison during the middle of the past century, U.S. electricity use grew 8 percent annually.  More recently, from 1990-2011 electricity use grew by 1.7 percent annually.   According to the Department of Energy, after a dip in electricity use during the recession, U.S. power consumption grew by 4.4 percent in 2010.  However, usage then declined by 0.8 percent in 2011 – a year in which real GDP grew by 1.7 percent.  This decrease in usage over the past decade has been caused by the increased focus on energy efficiency.  From 2004-2010 24 states, including Massachusetts, adopted the Energy Efficiency Resource Standards (EERS) which require utilities to save a certain amount of power each year, including the necessity for the savings to outweigh the costs.   

*The opinions and forecasts expressed are for informational purposes only and may not actually come to pass.  This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan.  The representative does not guarantee the accuracy and completeness, nor assume liability for loss that may result from the reliance by any person upon such information or opinions. All investments involve the risk of potential investment losses and no strategy can assure a profit. Past performance is not indicative of future results. 

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