Utilities to Outperform Semiconductors?

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The market didn't like what the Fed said, which left stock holders scrambling for the exits.

Some sectors took a greater hit than others, but did the right sectors take the brunt of the selling?

Don't discount utilities

The threat of rate hikes had the most impact on interest rate sensitive defensive sectors, like utilities in particular.

The Utilities Select Sector SPDR (NYSEMKT: XLU) quickly dropped below what had looked a turnaround opportunity in June. The sector leaders, CenterPoint Energy and EQT, had a mixed response, with the latter holding up better, although both have merits which I detailed here.

While a slowdown in the financial stimulus program will have an impact on the utility business, in terms of investing, this a sector which has been struggling since April's highs, not since Wednesday's announcement. While I'm not one to jump in with two feet (I would like to see the overall market come back more before I would be a concerted buyer), utility stocks - and the SPDR Exchange Traded Fund (ETF) in particular - are offering good value: high dividend yields, low historic interest rates, competitive Price/Earnings (P/E) ratios, and a tepid economy offer an environment within which utility stocks can blossom.

Other sectors are looking less attractive.

Technology and semiconductors look rich

A drop in Fed stimulus will pressure the still weak economy, and this will hurt cyclical sectors.

Technology is vulnerable because of falling demand for copper, but the effects of this have been hidden by the gains posted in the semiconductor sector. Copper prices have been steadily falling since February - part of larger decline dating to the 2011 high. However, the primary consumer of copper, the semiconductor sector, has been heading in the opposite direction. The Market Vectors Semiconductor ETF (NYSEMKT: SMH) had closely tracked copper prices from the 2009 low, but April saw this relationship change, with the ETF running higher as copper prices fell. The key reason for this was Intel Corporation (NASDAQ: INTC), which accounts for 17% of the ETF's price action, which saw higher prices as buyers sought a silver lining in their earnings miss.

Intel outshines Apple

It probably helped Intel that Apple, at the time, was making new lows: 'outperforming' Apple was seen as something good. So Intel's mediocre resilience, which it has endured for the best part of 10 years, was viewed as some form of positive. Intel's earnings have been steadily declining as the PC business continues to lose ground to the tablet sector. Number crunchers have squeezed value from the metrics, boosted by Intel's share buyback scheme, but there has been little from the company to suggest it deserves to be where it is.

Its earnings history has been a steady grind lower, and its most recent earnings release proved that even this may be too optimistic.There is an acknowledgement from the new CEO, Brian Krzanich, to become more responsive to its existing weakness in the smartphone and tablet market. But it will take time for Intel to claw back the ground lost to its rivals in this regard. In the meantime Intel investors seem happy to buy into future potential with a fresh face at the helm, rather than dwell on what's past.

Smartphone sales slowing

The bigger hit on the semiconductor sector, and the most likely explanation for the drop in copper prices, has been the slowdown in smartphone sales.

Samsung shed $12 billion in market cap as sales of high-end handsets lagged behind expectations, although cheaper models enjoyed brisk sales worldwide. But with copper demand falling, falling sales of mid- to low-end models will likely follow, squeezing already tight margins in this space. News of Samsung's miss hit smartphone component makers hard, discounting such stocks up to 11% in a single day.

In addition, Apple's underwhelming World Wide Developer Conference will have done little to excite investors looking for something fresh in the hardware space, or at the very least, an exciting iteration of an existing product to encourage an upgrade cycle.

Summary

With little on offer from leading technology manufacturers, it will be hard for the Market Vectors Semiconductor ETF to continue its trend higher. The semiconductor industry had factored for such weakness by reducing demand for copper, but investors in the space had apparently ignored the memo in the hope of something better. Until there is some stabilization in copper prices, it's probably best to take some profits off the table. 

Meanwhile, there is no love for Utilities, but the economic climate for the sector remains favorable and stocks in the sector trade at attractive discounts. 

With the various indices moving away from their highs in a more concerted manner, now is a good time to reassess the portfolio: cut the underperformers, take profits on the outperformers, and start looking at where the next opportunities lie.  


Declan Fallon owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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