Impact Of Tax-Loss Selling On Utility Stocks
Summary The utility sector has been a poor performer this year. Fully regulated utilities have likely been hurt by interest rate fears, while merchant power names have been hurt by lower power prices and tighter environmental regulations. The year end means many investors could be looking to harvest losses from the utility sector for tax purposes, keeping downward pressure on these names until we reach 2016. 2015 has been a tough year for utility stocks. At this point, it is the second worst-performing sector of the year. Only the energy sector, hit by the massive drop in oil prices, has done worse. Table 1 (click to enlarge) Source: FactSet The Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) is down over 8% for the year; its worst performance since the financial crisis. Table 2 (click to enlarge) Source: FactSet In some ways, this 8.1% decline is worse than it appears. Of the 29 current components of the XLU, only six were up for the year as of November 20. Table 3 (click to enlarge) Source: FactSet and The Select Sector SPDR Trust Of these six companies, TECO Energy (NYSE: TE ) and AGL Resources (NYSE: GAS ) got a big boost from becoming acquisition targets. NiSource (NYSE: NI ) and PPL Corporation (NYSE: PPL ) benefitted from corporate restructuring events. NI spun out Columbia Pipeline Group (NYSE: CPGX ) on July 1, and PPL spun out their merchant power business to create Talen Energy Corporation (NYSE: TLN ) on June 1. Pepco Holdings (NYSE: POM ), while down over 3% YTD, was also supported by corporate activity. They are being purchased by Exelon (NYSE: EXC ) for $27.25/share. This deal has been dragging on a long time, and in August the DC Public Service Commission voted against the merger. The stock promptly went below $23. Exelon has continued negotiating in our nation’s capital and the stock is now back near $26. Chart 1 (click to enlarge) Source: FactSet If negative news about the POM/EXC deal appears before year end, a big drop in the stock should be expected, further hurting XLU performance. After such a strong year in 2014, utilities were bound to have a difficult time in 2015. But the year actually started off strong, with utilities up significantly and well ahead of the market. At that point, utility valuations were stretched to record levels (see article here ), and it was going to be difficult for utilities to do anything but go down. The potential of a Fed rate increase has also been a likely culprit in hurting utility shares. Companies with merchant power exposure, like NRG Energy (NYSE: NRG ) and FirstEnergy (NYSE: FE ), have taken big hits because low natural gas prices have led to lower power prices this year. Tightening environmental regulations have also played a role, adding significant costs to keep some plants running. Now, with the end of the year upon us, these beaten-down companies will have another headwind to deal with: tax-loss selling. Investors will be looking for ways to offset any winners, and the utility industry should have lots of names customers can take a loss on. The bottom five XLU components all have losses larger than 20%. Table 4 (click to enlarge) Source: FactSet and The Select Sector SPDR Trust A downward spiral that creates more selling pressure could occur: investors sell the worst performers, hurting YTD XLU performance; which leads more people to sell the XLU, hurting all names in the group; leading to more sales in some of those names, further weakening XLU performance; leading to more tax-loss selling in the XLU. Eventually an equilibrium will be reached. Further risk to the demand for utility stocks could come from underperforming mutual funds that invested in the underperforming utility sector. If these funds suffer from significant customer redemptions, they could be forced to sell utility shares to raise cash. All of this selling pressure makes a year-end rally in utility names appear unlikely. Maybe if the Fed decides to hold off hiking interest rates in their December meeting, the group could get some momentum, but the reality is that utility shares should finish 2015 with their worst-performing year since the financial crisis. Of course, with everybody selling, this could be a buying opportunity. To harvest a tax loss, investors cannot reinstate their position for 30 days after they sell. So sellers of a name will be out of the market for a while. Investors with conviction on certain utility names should consider buying now, while many other people are selling for reasons other than the company’s value. This opportunity will disappear in January.