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Trade of the Day: Utilities Select Sector SPDR ETF (XLU)

We expect XLU to decline to February’s lows near $47.75

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Today, we’re opening a new bearish trade on the Utilities Select Sector SPDR ETF (NYSEARCA:XLU).

Utilities continue to be dragged down as an underperforming sector in the current market environment. A short-term rate hike by the Fed on Wednesday seems like a foregone conclusion, and traders haven’t shifted much over the last week on estimates for the pace of future hikes. Prospects for higher, longer-term rates have improved recently as well. Besides addressing the short-term rate, Fed Chairman Jerome Powell will likely also comment on inflation expectations and economic growth. Considering the economic data we have seen recently (rising hiring, industrial production, etc.), it seems very likely that the Fed’s comments will be more hawkish about inflation (and therefore interest rates) than dovish.

This presents an interesting opportunity in the utility sector. A cool spring, moderate energy prices and rising long-term rates should continue to make the utility sector unattractive for new buyers. The consumer-defensive sector has been able to surprisingly postpone selling through escalating buybacks and non-repeating industry news for merger and acquisition activity. However, utilities aren’t expected to have this kind of flexibility to defend against the damage higher interest rates will do to their dividends. A lower-value dividend combined with a generally bullish market should send prices on XLU lower in the short term.

From a technical perspective, XLU broke support last Wednesday, and we feel it has successfully retested that level as a new resistance pivot. We expect the ETF to decline to February’s lows near $47.75 in the short term, but a move lower than that is certainly possible. If expectations for short-term rate hikes rise after the Fed’s statement on Wednesday, we would expect a very high probability for a further decline to $46 per share.

‘Buy to open’ the XLU July 20th $48 Put (XLU180720P00048000) for a maximum price of $0.80.

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