The utilities sector of the S&P 500 as represented by the Utilities SPDR (ETF) (NYSEARCA:XLU) is higher by 23% year-to-date, versus just 5% gains for the broader index. Most investors by now are aware that this relative strength of the utility sector has come on investors chasing yield in an environment in which bond yields are literally collapsing.
While this rally in the XLU ETF might continue for some time, in the near-term, it increasingly looks like a pause is in order.
The lesson to be learned by the meaningful outperformance of the XLU is that while any one market may act difficult at any given point in time, there is always a bull market to be found somewhere else.
Last Friday’s better-than-expected June jobs report headline resulted in a rally not only in stocks across the board but also in commodities and bonds. Curious? I agree. The way I see it, either we are now moving in a new risk-on environment where stocks blast higher and money rotates out of bonds and bond-like stocks such as utilities, or last Friday’s rally in stocks was a head-fake and will soon falter again.
I say this because utilities and consumer staples cannot lead to a sustainable rally in stocks without more meaningful participation from the rest of the market.
XLU ETF Charts
Looking at the XLU ETF through a multiyear lens, we see that since the early 2000s, this vehicle has seen a couple of trending moves higher, each of which saw orderly pullbacks each time the rally got too extended. The most recent rally over the past couple of weeks has once again pushed the XLU marginally above the upper end of the multiyear trading channel/range, where I believe risk-reward on the long side is bad at best.
From this perspective, a pullback or at least a sideways consolidation phase in the XLU ETF is in order.
On the daily chart we see that this recent rally has also pushed the stock to the upper end of what may be looked at as a rising wedge pattern and here too this rate of change higher is likely unsustainable. At the bottom of the chart I plotted a ratio of the XLU versus the SPDR S&P 500 ETF Trust (NYSEARCA:SPY), which shows that relative outperformance of utilities year-to-date.
Active investors and traders could consider selling part of their XLU holdings and re-buy at lower levels. Alternatively, quicker hitters may consider shorting the XLU or using put spreads to express a near-term consolidation view using a downside price target near $50.
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