Investors are falling over themselves to get a piece of the market, rallying the major indices by historic proportions over the past two days.
While we’re on board with picking up some bargains on the volatility, we’re also looking at the rally with some skepticism. But before the market took its hard turn lower, one sector was presenting a low volatility “buy” signal that we’re still acting on, utility stocks.
Investors started throwing utility stocks away last year on fears that interest rate hikes would affect their attractiveness to yield investors. Shares of the Utilities SPDR ETF (XLU) hit a low at the end of June as investors overcorrected while the rest of the market was trying to break out of its six-month range. The sector posted a 10% stealth rally in July and August as the rest of the market went the other way.
Now, after less than a week of selling, utility stocks are in position to rally another 10% over the short run, with another potential 10% to follow as investors adjust to the possibility that interest rates may remain contained for longer than anticipated.
Here are the best ways to play the upcoming rally in utility stocks.
Utility Stocks to Buy: Utilities SPDR ETF (XLU)
Click to EnlargeThe easiest and least volatile way to jump on the utility rally is through the Utilities SPDR ETF (XLU). The recent pullback knocked XLU shares down to the $42 level, the site of significant chart support. Now the XLU shares throw off a nice 3.6% dividend yield, drawing the attention of yield hunters.
Breadth within the XLU is strong, as more than 70% of its component companies are still trading above their respective 50-day moving average. For comparison, the current percent of S&P 500 companies trading in similar territory is less than 10%.
Technical support, positive breadth and a solid dividend yield make XLU a great core position for most investor’s portfolios. Expect the XLU to reach above $46 in the near future.
Utility Stocks to Buy: Southern Company (SO)
Click to EnlargeSouthern Company (SO) operates as an electric utility involved in the generation, transmission and distribution of electricity through coal, nuclear, oil and gas, as well as hydro resources. Fundamentally, earnings and revenue have remained relatively strong against the market, resulting in a positive dividend growth.
Sentiment towards the company’s shares is decidedly pessimistic. Analyst recommending the stock as a buy only account for five percent (yes, only 5%) of the community. We like stocks in this position as the likelihood of upgrades is higher than downgrades, which can help propel the stock upward. This is especially true on stocks with strong or improving technicals.
As for SO’s technicals, the charts suggest support at $42 and an improving intermediate-term price trend that is now targeting a move to the $48 level before year-end.
Utility Stocks to Buy: Consolidated Edison (ED)
Click to EnlargeAnother Utility stock that is ready to outpace the market and its peers is Consolidated Edison (ED), a regional utility operator serves the New York area. Over the past three months, ED shares have handily beaten the S&P 500 performance as well as the performance of most utility stocks.
The positive technical performance has resulted in a long-term bottom and new long-term bullish trend that is now targeting a move back to $72.
Sentiment towards the stock will help fuel the move higher because Wall Street and the short sellers are on the wrong side of this market performer. The current ED short interest ratio stands at a lofty 8.9, suggesting that a short covering rally is likely as the stock crosses back above the $65 to $66 range.
Similarly, analysts are on the wrong side of the trade with only 6% of current ratings falling in the “buy” category. ED stock’s continued success will result in upgrades, which help move prices even higher.
The charts and pessimistic sentiment suggest that ED is ready to climb a “Wall of Worry” all the way back to $72 by year-end, nearly 15% higher from current prices.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.