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Investing.com -- In a note to clients Tuesday, Jefferies analysts presented a mixed view on Utility stocks, maintaining an Overweight rating in large-cap Utilities but an Underweight rating in small-cap Utilities.
While sentiment toward the sector remains strong, with inflows into ETFs, Jefferies’ strategy team holds diverging opinions based on market capitalization.
Sentiment for Utilities has been "very strong and provides a nice tailwind for the group," partly because "many of the stocks will help with the AI build out."
Despite the sector’s lower liquidity, Jefferies notes that "flows are currently in the sweet spot, not too hot and not too cold."
Addressing the "higher for longer" interest rate environment, Jefferies believes it’s "not really" a "death knell for this sector."
The firm’s forecast suggests rates will hover close to current levels, with three Fed Funds cuts expected in 2025 starting in September.
While Utilities in small caps are more tied to rates, Jefferies notes that the correlation is weak in large caps.
Interestingly, when the Fed funds rate falls, Utilities typically lag, which "has not been the case in this rate reduction environment."
However, Jefferies points out that if investors are seeking yield, "the dividend yield is below both the 10-year and the 2-year," suggesting "one can find cheaper dividend-paying stocks elsewhere."
Valuations are also said to be a concern, with Utilities viewed as "expensive in both size segments."
Jefferies’ overall view leans towards Overweight large-cap utilities due to attractive valuations and strong earnings visibility, while being Underweight in small caps where Utilities are among the "most-expensive groups and does not provide enough economic torque."