Why Morgan Stanley Favors Dull Utility Stocks Over Techs

Inflation is finally starting to peak its head, but it is whether or not inflation becomes “unhinged” that really has equity investors worried. Amid the inflation uncertainty, the broad market sell-off over the past week has turned Morgan Stanley strategist Mike Wilson towards a more defensive strategy. He suggests moving away from the cyclical technology sector and into utilities, which are much more resistant to fluctuations in the performance of the overall economy, according to CNBC.

As of the close of trading on Tuesday, the FAANG technology stocks are up an average of 13% year to date. Facebook Inc. (FB) is up 5% so far this year; Amazon.com Inc. (AMZN) is up over 23%; Apple Inc. (AAPL) is down about 3.5%; Netflix Inc. (NFLX) is up more than 38%; and Google’s parent Alphabet Inc. (GOOG) is up a little over 3%.

The Utilities Select Sector SPDR ETF (XLU) is down a little more than 8% since the start of the year. Among its top ten holdings, NextEra Energy Inc. (NEE) is down just over 4% for the year; Duke Energy Corp. (DUK) is down more than 11%; Dominion Energy Inc. (D) is down about 8.5%; Southern Co. (SO) is down about 9.5%; and Exelon Corp. (EXC) is down just under 7.5%.

Tech Sector Woes

Don’t let the recent strength in tech blind you from what the future might bring. Downgrading the tech sector from overweight to equal-weight in a note issued on Monday, Wilson warned, “Technology does not look very good. In fact, it looks downright awful.”

In his note, Wilson also noted that while earnings revisions have looked good for the S&P 500 as a whole, they look very bad for the tech sector. The tech sector’s earnings revisions breadth, a measure that subtracts downward revisions from upward revisions and then divides by the total revisions, has fallen below 10%, indicating that downward revisions are climbing relative to that of upward revisions, according to Barron’s.

Much of that weakness is coming from excess semiconductor inventory, most notably evidenced by Apple’s poor sales results of its newest iPhone. Software and service companies have also shown poor performance in recent weeks. (To read more, see: Long-Time Tech Analyst Advises Sector Overvalued.)

Utility Sector Turnaround

Despite the weak performance of the utility sector since the start of the year, Wilson believes the sector is poised to rise. He upgraded his rating for utilities to overweight.

Traditionally, utilities stocks have been regarded as proxies for bond prices, meaning that if bond yields fall then utilities stocks should rise. The recent uptick in Treasury yields has coincided with the recent weak performance of the utility sector, but Wilson doesn’t believe in the current “sustainability of the level of yields,” arguing that a “retracement” of yields will take place “at some point in the not too distant future,” according to CNBC. (To read more, see: How Utilities ETFs Deal With Rising Rates.)

If he’s right, trading in tech stocks for utilities may be good protection in the changing economic environment.

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