If the Market Crashes, Will Utility Stocks Protect Your Portfolio?

Investors are worried. CNN's Fear and Greed Index is at "extreme fear." Inflation remains persistently high, with the ongoing Iran war and tariffs not helping matters. Stock market valuations are frothy by most metrics.

In times of uncertainty, many investors look to safe havens. Utility stocks rank high on the list. But if the stock market crashes, will utility stocks really protect your portfolio?

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The case for utilities

Arguments for buying utility stocks as a defensive portfolio move make sense. Consumers don't stop using electricity, natural gas, or water during an economic downturn or stock market sell-off.

There's also historical precedent for utility stocks protecting against a market crash. For example, the S&P 500 (SNPINDEX: ^GSPC) sank almost 50% from its peak in early 2000 by October 2002 when the dot-com bubble burst. The Nasdaq-100 index plunged more than 80%. Meanwhile, shares of NextEra Energy (NYSE: NEE) and The Southern Company (NYSE: SO), both large electric utility providers, jumped more than 20% during the same period.

Fast-forward to the 2008 financial crisis. Utility stocks, including NextEra and Southern Company, fell along with the broader market. However, many utilities held up much better than the S&P 500. The Southern Company's shares briefly declined more than 30% from the previous high, but that wasn't nearly as bad as the S&P 500's sell-off of more than 50%.

Utility stocks also provide a cushion of sorts even when they do fall. Many pay attractive dividends. Reinvesting those dividends when share prices retreat allows investors to buy at a discount and boost their long-term returns.

The case against utilities now

One knock against utility stocks as a hedge is that not all of them provide strong downside protection. For example, the State Street Utilities Select Sector SPDR ETF (NYSEMKT: XLU), which currently owns 31 utility stocks, sank more than the S&P 500 did during the 2000 through 2002 market downturn and nearly as much as the index did during 2008 and 2009.

Another key issue in 2026 is that interest rates have risen and are likely to continue moving higher. Utilities tend to be sensitive to interest rates because many have large debt loads. Additionally, utility stocks compete with bonds for income investors' attention. With 10-year U.S. Treasury bonds yielding 4.95%, the dividends offered by many utilities may not be as appealing as in the past.

There are also new risks for utility stocks today. Much of the growth in the demand for electricity and natural gas is being driven by artificial intelligence (AI). The data centers that host AI applications require massive amounts of electricity. Natural gas is the top fuel for power plants in the U.S.

However, some believe that we're in an AI bubble. If they're right and this bubble bursts, utility stocks could be hit hard.

Answering the question

Let's return to the initial question: Will utility stocks protect your portfolio if the stock market crashes? I think the answer is nuanced.

Yes, many utility stocks should weather a steep market downturn better than the overall market. However, some may not. After the dot-com bubble burst in 2000, for example, Duke Energy's (NYSE: DUK) shares plunged significantly more than the S&P 500.

Even utility stocks that perform well during one market sell-off can decline sharply during another downturn. We saw this happen with NextEra Energy and Southern Company during the 2008 financial crisis.

Overall, though, utility stocks should provide some downside protection during a stock market crash but not full protection. For income investors wanting greater protection, other alternatives such as short-duration Treasuries and blue chip dividend stocks could be worth considering.

Keith Speights has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends NextEra Energy. The Motley Fool recommends Duke Energy. The Motley Fool has a disclosure policy.