Wells Fargo downgrades Utilities to neutral after YTD rally

Wells Fargo analysts have downgraded the Utilities sector from Overweight to Neutral on Thursday, following a strong year-to-date (YTD) rally.

Analysts had previously upgraded Utilities in late 2023, when negative sentiment was high and technical indicators suggested the sector was oversold. However, conditions have shifted, with Utilities returning 25.8% YTD, outpacing the S&P 500’s 19.1%.

Wells Fargo’s team cited three key reasons for the downgrade.

First, the sector no longer represents a non-consensus oversold group, as was the case during last year’s upgrade. Several peers have also recently upgraded the sector, signaling broader consensus.

Second, the anticipated risk-aversion bid due to uncertainty is now priced into the market, reflected in the strong performance of low-volatility stocks across the board.

Lastly, the rates market appears to have already priced in this year’s monetary easing, with key indicators such as the 2-year U.S. Treasury yield and Federal Reserve projections aligning with expectations.

Wells Fargo is also retiring its two-year recommendation for a sector barbell between Communication Services and Defensives, which outperformed in the past two years. Analysts now encourage investors to seek opportunities in midcap growth, which they believe offers an “attractive risk/reward with reasonable downside protection.”

They highlight that the S&P 400 Midcap Growth index is currently positioned for an oversold bounce and that it has rallied in double digits YTD.

Moreover, they point out several appealing factors for midcaps, including earnings stability, a solid liquidity position, and a more attractive balance sheet compared to small caps. In addition, the group’s relative price-to-earnings (P/E) valuation stands at approximately 90% of the S&P 500.