Utilities SPDR (ETF) (XLU) — The question on everyone’s mind this week is whether the Federal Reserve will raise interest rates for the first time in nearly a decade. I don’t know, my inner circle of hedge fund colleagues doesn’t know, and chances are that unless you have a crystal ball, you don’t know either.
No one should be surprised if the Fed does considering its language of late. On the other hand, we are late in an economic recovery cycle and a number of data points show economic growth has slowed this year.
While the central bank may end its zero percent interest rate policy, I remain of the opinion that rates will remain low for a considerable period of time. In such an environment, XLU may be traders’ best friend.
Utility stocks pay dividends that look more attractive as interest rates fall (or remain low). Currently, XLU yields about 3.8%. Despite some market risk, utility stocks will likely remain attractive to investors compared to the yield of the 10-year Treasury note, currently at about 2.2%.
On the monthly chart, we see XLU overshot its defined trading range in late 2014 and has since mean-reverted back to the lower end of this range. Note that XLU also sits below its 17-month simple moving average (blue line), which has held as solid support since 2010.
On the daily chart below, we see XLU made an important lower high in August. It also looks to have traced out a major head-and-shoulders pattern that, by definition, has bearish implications.
With these somewhat conflicting signals in multiple time frames, what’s an active investor to do?
The trade I see setting up is as follows:
- A breakdown below the neckline near $41 could result in capitulation selling that leads to a better buying opportunity; or
- If XLU gaps higher after Thursday’s FOMC decision and can hold above $42.50 on a weekly closing basis, we could buy it for a multi-month trade with a first target in the $46 area.
