Direxion Daily Utilities Bull 3X Shares: An ETF To Avoid (UTSL)

Background

The utility sector index includes large companies that either offer multiple services or specialize in one of services that include electricity, natural gas, water, renewable and other services. Utilities are associated with stable prices, consistent dividends and less volatility than the overall equity market. Utility stocks are sought-after during recessions and economic slowdown; however, they fall out of favor during economic growth.

Pros of investing in the utility stocks are stable investments that provide regular dividends and slow and steady price increase over time. Growth could come through increased consumption from electric charging and hydrogen, replacing traditional gasoline based vehicles. Cons include regulatory oversight, costs of providing services, significant investment in infrastructure (which could result in heavy debt load), maintenance costs, and sensitivity to interest rates. US electricity sales rose 3.6% in 2022. However, costs had a spike in the first half of 2022 due to higher rates of natural gas, coal, and other commodities.

UTSL Overview

The Direxion Utilities Bull 3X Shares ETF (NYSEARCA:UTSL) seeks to perform 300% of the daily investment performance of the Utility Select Sector Index net of fees and expenses. The utilities sector index includes U.S. domestic utility companies, which could be electric utilities, water utilities, independent power producers, energy trades, and gas utilities.

Risk of holding 3X ETF

There is significant risk of holding three times leveraged funds. Leveraged ETFs are only for experienced traders and not an investment option. According to the Direxion fund prospectus on holding UTSL as an investment for the long term – “No, this is not recommended. Leveraged ETFs seek daily investment results and should therefore be considered primarily for short-term trading purposes. It may, however, be appropriate to hold the funds for periods longer than a single day, depending on the performance path of the fund’s underlying benchmark index and the investor’s risk tolerance. Investors who choose to hold leveraged ETFs for periods longer than a single day should recognize that their holding period is not in line with the fund’s investment objective, and such investors should regularly monitor and adjust their position to maintain a level of exposure consistent with their investment objective.”

Holdings

The biggest holdings NextEra Energy (NEE), Southern Company (SO), Duke Energy (DUK), Dominion Energy (D), and Sempra (SRE) are over 40% of the utilities index.

Expenses

Expense ratio is around 1%, which is significantly higher than the average annual fee for an ETF.

Charts & Valuation

Seeking Alpha author rates XLU as hold or strong sell in the last 30 days.

Below, we will review charts of utilities leveraged ETF (UTSL) and the five largest stocks in the S&P Utilities Index. UTSL has gone nowhere since its inception in 2017, with lots of swings up and down.

Comparison of UTSL to XLU since its inception in 2017, illustrates volatility in UTSL, which has resulted in no gain over XLU though it is leveraged 3X due to losses in down years.

NextEra Energy estimated earnings growth is 7.7% for 2023 though its valuation in terms of P/E is 29.5.

NEE chart is going sideways, and one has to watch for a breakdown.

Duke Energy is at P/E of 20 with growth in 2023 of 7%.

Duke Energy has bounced back over the past two months.

Southern Company is also at P/E of 20 with 2023 growth rate of 3.6%.

Southern Company chart is holding above the pivot and the cloud, but so far has made a lower low.

Dominion Energy growth is not expected in 2023 is at P/E of 15.

Dominion Energy has broken into a downtrend.

Sempra will hardly grow earnings while it has a price to earnings ratio at 18%+.

Sempra is coiling and needs to hold above the cloud.

Utility Sector Valuation

The S&P utility index is expensive and is about 20 times the multiples of its earnings, which puts it near the top in terms of valuation going back more than a couple of decades.

S&P utilities index is not going to generate a higher revenue per share in 2023, but there could be a small increase in 2024 according to consensus estimates.

Operating earnings per share for the S&P 500 utilities sector is going to show a small increase in 2023.

Projected profit margin for S&P utilities index has declined since 2021 and is not expected to bounce in 2023 or 2024.

Earning revisions for the S&P utilities index have negative revisions, and thus the profit margins are declining.

FINRA on Leveraged ETFs

Leveraged ETFs should be avoided unless a sophisticated trader uses them for day trading or short timeframe with strict risk management. FINRA warning:

“Exchange-traded funds (‘ETFs’) that offer leverage or that are designed to perform inversely to the index or benchmark they track-or both-are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.”

Summary

During an economic slowdown, most investors prefer steady dividends and low volatility. While utilities might have provided that in the past, the up move has already happened, and now is not the time to be long utility sector stocks. Big utility sectors are expensive in terms of valuation, with limited growth in 2023 or 2024. My recommendation would be to avoid UTSL both from a risk perspective (due to leverage) and any opportunity in going long (due to expensive valuation).