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Defensive weakness

Global yield compression has driven utilities to record highs, but fault lines are now beginning to show.
Defensive weakness

The utility sector is much vaunted for its defensive characteristics, so why have its constituents merely tracked, or in some cases underperformed the recent market malaise?

The answer is that recent statements from Fed chairman Ben Bernanke around the possibility of tapering quantitative easing (QE) threaten to stop one of the strongest macro-economic drivers behind share prices dead in its tracks. Utilities have risen to record highs as investors have chased the guaranteed inflation-linked yields on offer, driven into the sector by record low yields on savings and dividend cuts elsewhere.

The expectation that the Fed will soon start to slow the $85bn-a-month QE3 programme could reverse that trend. Yields on US and UK government paper have soared since the start of May. "If the bond market is in a bubble, then equity is the other side of the same bubble," said Peter Atherton, utility analyst at Liberum capital. Another feature of a potentially higher interest rate environment is that the level of debt in the highly leveraged utility sector will dampen the appeal of the equity as costs of servicing that debt rise.

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