Plying the Power Lines

Talk about a power play.

Low interest rates, the 2003 Bush dividend tax cut and good old fashioned momentum have lifted the Dow Jones Utility Index by more than 80% since the summer of 2002. The average utility fund is up 20% annually over the past three years, according to fund tracker Morningstar.

After three years in rally mode, can the utility sector keep the juice flowing? Some hard-hitters say yes.

"As long as the economy remains in a slow growth mode, the outlook remains good for utilities," says Judy Saryan, portfolio manager of the $761 million (EVTMX Quote)Eaton Vance Utilities fund. "The fundamentals have not changed."

Saryan's fund is up 11.4% this year and 23% annually over the past three years.

Saryan likes to see the economy looking more like a tortoise than a hare, because rapid growth could boost inflation and spur interest rates higher. Any spike in long-term rates could hammer these shares, because these companies tend to be big borrowers. Investors seek out utilities in low-interest-rate environments for their dividends.

Longtime players in utility stocks still fear a repeat of 1994-95, when the Fed essentially doubled the overnight lending rate, triggering a 33% plunge in the utility index.

A decade later, the Fed is once again trying to curb inflation by lifting short-term rates. But this time Fed Chairman Alan Greenspan's efforts have yet to bear fruit. Long-term interest rates are lower now than they were last year, when Greenspan started his tightening campaign. And many big-time bond strategists, such as Pimco's Bill Gross, don't foresee long rates heading north anytime soon.

Shaun Hong, co-portfolio manager for the $3.2 billion (PRUAX Quote)Jennison Utility fund, says "the entire stock market is in trouble if the yield on the 10-year Treasury goes up from 4% to 6%, not just utilities." Hong's fund returns have been far from troublesome for his investors: The fund is up 17% year to date and 27% annually over the past three years.

It's Not Just Low Rates, Stupid

Low interest rates aren't the only factor stoking the rally in utility shares. Higher commodity prices are also helping -- even though higher commodity prices often cause a spike in interest rates, and this brings us back to the Greenspan rate-curve conundrum.