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Member FINRA/SIPC
An eye on equity market trends
 
IMPORTANTDISCLOSUREINFORMATION:Please refer to thelast two pages forimportant disclosures.
Raging Bull
Utilities Sector Overview: Stable FundamentalOutlook Comes At Too High A Price
Jeffrey Buchbinder, CFA
Assistant Vice PresidentEquity StrategyLPL Financial
John Canally, CFA
Vice PresidentLPL Financial
Jeffrey Kleintop, CFA
Chief Market StrategistLPL Financial
Dave Reilly, CFA
Assistant Vice PresidentEquity StrategyLPL Financial
February 20, 2008
Page 1 of 7
• We recommend an underweight allocation to Utilities, primarily due to our interestrate outlook and rich valuations.• Due to low market interest rates, deleveraging and investor demand for defensiveinvestments, the Utilities sector has been on a tremendous run during the past severalyears.• Currently, we view the sector's limited sensitivity to the U.S. economy as a negative,given our macroeconomic view that recession will be averted.• We favor positioning in non-regulated independent power producers, integrated andnuclear power generators, though regulated utilities' relative positioning is improving.
We recommend an underweight allocation to Utilities
. Among the factors driving ourcautious view are: low relative yields, rich valuations, our expectation for a
fl
at-to-risinginterest rate environment, and political/regulatory changes. Strong capital investment,tightening capacity, and the potential for falling natural gas prices are positive offsets.Within the sector, we recommend the relative positioning shown below. Note that the S&Psub-sectors don’t match up with how investors analyze Utilities. Accordingly, we dividethe sector by regulated versus non-regulated and by the primary power source. A moredetailed discussion supporting these views can be found at the end of this report.
Utilities Sub-Group Recommendation/OutlookRegulated Utilities Neutral to NegativeIntegrated Utilities Neutral to PositiveIndependent Power Producers Neutral to PositiveNatural Gas and Coal NeutralNuclear Positive
Source: LPL Financial Research
 
Raging Bull | February 20, 2008 | Page 2 of 7
Utilities have been on quite a run the lastseveral years.
The Utilities sector has beenon a tremendous run during the past fouryears, generating double digit returns andoutpacing the market during each of thoseyears. Since the start of 2004, the S&P500 Utilities sector index has gained 95%in total, compared to the 21% increase inthe S&P 500.The sector’s strong performance has beendriven by several factors. Perhaps thebiggest factor has been low interest rates.Utility companies are traditionally oneof the best places for equity investors tolook for yield. When yields on alternativeincome investment choices are low, theutility company dividends look especiallyattractive. As market yields offeredby bonds and other income orientedinvestments such as REITs have fallenduring the past several years, yields onutility stocks have looked especiallyattractive on a relative basis. The lowinterest rate environment has alsoprovided the industry with an opportunityto deleverage.Looking forward, even with market yieldsas low as they are, Utilities sector dividendyields look relatively less attractive. Thechart below shows that as yields for the S&P500 have risen, yields for the Utilities sectorhave fallen. As a result, the relative yieldadvantage enjoyed by Utilities over the restof the market has diminished, contributingto our underweight recommendation. Inthe
fl
at-to-rising interest rate environmentwe foresee in 2008, this sector is likely tounderperform.
Utilities have been onquite a run the lastseveral years.Another factor that hascontributed to Utilities'recent outperformance,at least during the lastyear or so, is its relativeinsensitivity to the U.S.economy.
LPL Financial Member FINRA/SIPC
 
919.0%7.5%6.0%4.5%3.0%93959799010305076.5%5.5%4.5%3.5%2.5%
30 Year Treasury Yield (left scale)S&P 500 Utility Index Level (right scale)
Source:FactSet Research Systems, Bloomberg,LPL Financial Research
1312111090807060504001 02 03 04 05 06 07S&P500 (TR) / Utilities - SEC (SP821.R) 119.9S&P500 (SP50) 102.1
Utilities have had a solid four-year run
Indexed Price29-Dec-2000 to 19-Feb-2008 (Weekly)29-Dec-2000=100; Local
Source:
 
LPL Financial Research, FactSet
65432165432199 00 01 02 03 04 05 06 07
Source:S&P/H, S&P/ Haver 2/19/08
Utilities Yield Tracks Treasury Yield
Year on 30-Year Treasury Bond and S&P 500 Utilities Sector Yield
Utilities' Relative Yield Advantage is Shrinking
S&P 500:: Divided Yield Close: Utilities%S&P 500 Composite: Divided Yield%
 
Raging Bull | February 20, 2008 | Page 3 of 7
Another factor that has contributed toUtilities recent outperformance, at leastduring the last year or so, is its relativeinsensitivity to the U.S. economy.
Sincethe onset of the subprime mortgage crisis inthe summer of last year, which marked therecent peak in Treasury yields, investorsincreasingly looked toward the Utilitiessector for a defensive investment. Sincemid July 2007, the sector has outperformedthe S&P 500 by more than 10 percentagepoints.Further demonstrating the sector’s relativedefensive nature was very strong relativeperformance from mid 2000 through mid2001, during the early part of the lastrecession and prior to the onset of theCalifornia electricity crisis and Enrondebacle. Though deregulation and thebursting of the Tech bubble played a sizablerole in the strong relative performance, itis noteworthy that the sector outperformedthe S&P 500 by 40% during this timeperiod. Should a recession occur, whichwe do not expect, the Utilities sector mayoutperform—though not as dramaticallyas in the 2001 recession.
Currently, we view the sector’s limitedsensitivity to the U.S. economy as anegative, given our macro economicview that recession will be averted.
Weexpect the U.S. economy will re-accelerateduring the second half of this year. As aresult, we believe economically sensitive,growth-oriented areas of the market arewell positioned for growth and attractivelypriced. We would focus investments inthese areas, including Technology andIndustrials. Health Care, another growth-oriented sector, is also favored, though itoffers similar relative insensitivity to theeconomy. These sectors are all bene
fi
tingfrom large international businesses, whichutility companies lack.We would also point out that utilitiesare predominantly consumer orientedbusinesses and face some risk on thedemand side if the consumer spendingenvironment deteriorates further.For more information on our sector views,please refer to Jeff Kleintop’s most recent
Sector Strategy
report.
Still a proxy for oil prices?
A number of utilities have bene
fi
ted from higher energyprices, but this relationship has fadedduring the last 12 to 18 months. The utilitycompanies had been able to pass alonghigher prices to the end consumer in manycases as oil prices rose, while bene
fi
tingfrom cheaper natural gas and coal inputprices. This relationship held through mid2006 but has broken down since then,partly due to higher natural gas and coalprices. Going forward, if utility companiesget margin support, we believe it is morelikely to come from falling natural gas andcoal prices than rising energy prices.
Currently, we viewthe sector’s limitedsensitivity to theU.S. economy as anegative, given ourmacro economic viewthat recession will beaverted.
LPL Financial Member FINRA/SIPC
1601501401301201101009080706098 99 00 01 02 03 04 05 06 07S&P500 / Utilities (SP821) 139.1S&P500 (SP50) 136.5
Strong relative performance ahead ofenergy crisis and previous recission
Indexed Price27-Feb-1998 to 20-Feb-2008 (Monthly)30-Jan-1998=100; Local
Source:
 
LPL Financial Research, FactSet
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