President Donald Trump has imposed a 20% tariff on imports from China and a 25% tariff on imports from Canada and Mexico. He has also mentioned applying a 25% tariff on imports from Europe. All countries impacted by the taxes have either taken or plan to take retaliatory action, and Trump has already threatened reciprocal retaliation.
The nonpartisan Tax Foundation estimates that the tariffs proposed by President Trump will raise the average tax on U.S. imports to 13.8%, the highest level since 1939. Investors are worried about the consequences of a trade war. From their highs, the S&P 500 (SNPINDEX: ^GSPC) has fallen 6% and the Nasdaq Composite (NASDAQINDEX: ^IXIC) has declined 9%.
The utilities sector could benefit (or at least incur less damage), compared to other stock market sectors, as the trade war weighs on the broader stock market. That makes the Vanguard Utilities ETF (NYSEMKT: VPU) a compelling investment idea right now.
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In January, JPMorgan Chase strategists, led by Thomas Kennedy wrote, “The net impact of the tariffs and the implications of the administration’s policy goals are likely to benefit the industrial sector as well as the utility sector, where infrastructure buildout will be required.”
Additionally, Tariffs should theoretically strengthen the U.S. dollar by reducing demand for foreign imports, which would curb demand for foreign currency. The Federal Reserve may also raise interest rates to combat tariff-induced inflation, which would incentivize foreign investors to buy U.S. bonds, creating demand for U.S. currency.
How will tariffs impact foreign-exchange rates? This becomes more difficult to predict as foreign countries impose retaliatory taxes. But tariffs in 2018 and 2019 did strengthen the U.S. dollar, and a stronger U.S. dollar creates foreign-exchange headwinds for companies that earn revenue in international markets.
Utilities-sector companies derive less than 1% of their revenue from international markets, so they have virtually zero exposure to foreign-currency headwinds. For context, international-revenue exposure in the other stock market sectors ranges from 18% in real estate to 56% in technology.
Here’s the bottom line: Utility stocks may be unscathed by tariffs because most of their revenue comes from the U.S. They may even benefit from tariffs as the reduction in imported goods may lead to greater domestic manufacturing activity, creating demand for electricity, gas, and water.
The Vanguard Utilities ETF tracks 69 U.S. companies in the utilities sector. The index fund is most heavily weighted toward electric utilities (61%) and multi-utility companies (25%). However, it also provides exposure to independent power producers (6%), gas utilities (5%), and water utilities (3%).
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The five largest holdings in the Vanguard Utilities ETF are listed by weight below :
NextEra Energy: 11.2%
Constellation Energy: 7.1%
Southern Company: 7.1%
Duke Energy: 6.6%
Vistra: 4.4%
Beyond tariffs, companies in the utilities sector have another tailwind in the growing demand for artificial intelligence (AI). On average, ChatGPT requires 10 times more electricity per query than traditional internet search engines. Consequently, Goldman Sachs strategists anticipate electricity demand will accelerate “through the end of the decade to levels not seen in 20+ years.”
The Vanguard Utilities ETF returned just 21% during the last three years, which falls short of the 40% return of the S&P 500. However, the utilities sector is well-positioned to outperform the broader market in the next three years as data centers consume more electricity and tariffs weigh on other sectors.
Utilities companies, in aggregate, reported earnings growth of 16% in the fourth quarter. That makes the sector-level valuation of 20 times earnings look reasonable. And the Vanguard Utilities ETF has a cheap expense ratio of 0.09%, so shareholders will pay only $9 per year on every $10,000 invested in the fund.
I have only one caveat: I would keep my position in the Vanguard Utilities ETF small. While I believe it’s the best Vanguard index fund (or at least one of the best) to buy as tariffs hit the stock market, I also think the technology sector will outperform the utilities sector over the next decade. I would use tariff-driven selling to build positions in technology stocks, too.
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JPMorgan Chase is an advertising partner of Motley Fool Money. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends JPMorgan Chase, Goldman Sachs Group, and NextEra Energy. The Motley Fool recommends Constellation Energy and Duke Energy. The Motley Fool has a disclosure policy.
Opinion: The Best Vanguard Index Fund to Buy as President Trump’s Tariffs Hit the Stock Market was originally published by The Motley Fool
