We now live in a world where every major central banker is in a race to lower rates. Consequently, yields have been demolished. What’s worse is that they are not abating. One consequence is that utility stocks became popular to investors because they typically pay dividends. The point today is to avoid getting into them just for that reason.
The U.S. Federal Reserve tried to tighten credit in 2018 but failed. They first stopped buying bonds then they started a tightening cycle. Then they capitulated after causing the Christmas crash of 2018. This global dovish stance created the phenomenon we call TINA. It stands for There Is No Alternative, where investors seek assets like utility stocks by default. They pay dividends and that makes them attractive.
Ever since Fed Chair Jerome Powell raised the white flag in 2018, he’s been committed to keeping rates at zero. Consequently, there is no hope of interest payout anywhere. Those seeking fixed income used to buy bonds. Doing so now would even cost you money overseas. In the U.S. they barely pay at all. These central bank strategies, while they are dovish stock markets, they exacerbate asset bubbles. They pushed fixed income investors who normally buy boring “safe” bonds into chasing yield up the risk curve.
The prevailing idea here is that utility stocks are the place to be. They became a “buy” by default. When the masses are in this much agreement, I worry. What also raises the threat level is the fact that yields could be basing for a big recovery rally. The TNX chart for example, after falling for so long, is making a long-term bottom. It’s a process and it has already started as long as it maintains the higher-low trend.
Nothing rallies forever. Today’s stock charts suggest that they may be headed into resistance zones. It is best to book the profits and re-enter lower. Here are three utility stocks in particular that you should look out for:
Utilities Select Sector SPDR Fund (XLU)
Wall Street loves to invest on popular themes these days. It’s probably because of social media where it’s so easy to propagate ideas. Somewhere someone starts a trend and with enough followers, it catches fire. This creates problems for those who join the party a bit late. They end up buying the early birds’ profits. This may be the case in utility stocks. To bet on this thesis, I suggest fading the XLU ETF.
The fundamentals in utility stocks are not typically the kind investors chase on breakouts. They are usually sought after as safer trades. Utilities have been the dividend payers and this concept, thanks to the Fed, is at an extreme point. Collecting 3% seems like the 10% of olden days because the U.S. 10-year barely yields 0.75%. In a bullish stock market, owning strong stocks with yield seems much smarter.
Therein lies the problem. In January, the XLU ETF rallied 10% and I bet they looked like a great idea. Those who bought them near $70 quickly suffered big losses. They are still well under water down 11% or so. There is overhead resistance so the rallies from here will not be easy. The bulls are fighting with the February crash level. It will be a tough slog to rally into $66 per share. Therefore, a pullback is the more likely outcome.
NextEra Energy (NEE)
Shorting the XLU means also betting against its components. NEE stock is the largest one with a 16.4% piece of the total pie. The bearish concept that I just shared about the XLU chart is truer for this one. NEE is still above its February “accident scene,” which means more potential downside risk. Perhaps the extra mojo in NEE came from a recent stock split. We all know how much the 2020 investors love chasing splits like the one that Tesla (NASDAQ:TSLA) and Apple (NASDAQ:AAPL) did.
If we agree that XLU is extended, then so is NEE stock. If the equity markets correct more into the political mess this or next week, then this has 7% downside risk. There is short-term support near $74 per share, but the better level is closer to $70. As with most of my bearish write ups, this is not a knock against the company. I have issues with the stock chart, where I see better odds of downside than upside.
This slightly bearish thesis would be broken if NEE goes above $77 per share. Then the trade becomes to chase the rally into thin air. The daily chart looks like a Loch Ness monster and that’s usually not a good base. The bulls need to pull back a bit to retest the necklines for better footing. This is not the same as me calling for an all out short because of a fundamental flaw. I leave those calls to the “experts” in the field.
Duke Energy (DUK)
My issues with DUK stock are similar to NEE, but also more akin to XLU. Like NEE it too is a large component of the utility stock ETF. But with only 8%, it’s half as big as NextEra. What makes it more like the XLU is that it is below its February highs. This makes it less of an egregious situation, but still too high. It’s one thing to recover from a crash, but it’s another to comeback and beat it like NEE did.
It is counter intuitive to do so unless it is a new tech concept like the one in Zoom (NASDAQ:ZM) for example. With ZM, it makes more sense that there is 300% growth because it’s based on a new trend. There is no such thing in utility stocks. The macroeconomic conditions are still depressed and the micro-fundamentals are unchanged.
In simple terms, there are no miracle rallies in this segment and there could be too much froth. If the bulls can take it above $94 per share it could carry momentum. But it’s more likely to fade into $88, then $84 per share instead. The battle is between overhead resistance, where a whole bunch of longs are trapped and a vacuum below. There are two high volume points of interest this year at the lower levels we just noted.
Chasing these theories is rarely a good idea unless it’s very early in the process. The TINA concept is long in the tooth and I think chart technicals will be in play in November. It would also be wrong to ignore that we are coming into extreme risk from the election headlines. All theses have to come with humility. Meaning, you shouldn’t stay stubborn if the price goes against these moves and I keep trades small.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.