This chart of utility stocks relative to the S&P 500 is very interesting to me.
Why? Because the relative relationship between the most offensive part of the stock market against the most defensive sector of the stock market is a sentiment “tell.”
Utilities are often referred to as the most bond-like sector of the stock market. This comparison stems from the sector’s dividend yield characteristics, which are similar to the fixed interest payments of bonds. Utility stocks generally offer high dividend yields, making them attractive to income-seeking investors, particularly in low-interest-rate environments. Moreover, utility companies often operate under regulated frameworks, which can lead to predictable earnings, resembling the fixed income from bonds.
What Utility Stocks Tell Us
Historically, the utilities sector has tended to move in advance of high-volatility, risk-off junctures for the broader stock market. I’ve proven this in a paper showing that going back to 1926, utility stocks lead high-risk junctures, on average. This movement can serve as an early warning system for investors.
When uncertainty increases, investors often reallocate funds from more speculative assets to defensive ones. This defensive shift typically boosts the performance of utility stocks before other sectors begin to feel the impact of market turbulence.
The simultaneous rally in gold and Treasurys at the time when utilities may have bottomed on a relative basis, is worth paying attention to here. Investors traditionally see gold as a hedge against inflation and currency devaluation, while Treasury bonds are a classic risk-off asset that investors seek out during times of market distress. The concurrent strength in these assets, along with utilities, signals a broader move toward safety by investors. This could indicate concerns about market stability or the outlook for economic growth in the short term independent of the S&P 500’s uptrend.
The rally in gold and Treasurys could have several implications for the utilities sector:
- Inflation Concerns: If investors are buying gold due to inflation worries, utility stocks may benefit. Utilities can often pass on higher costs to consumers, which can protect their earnings from the erosion of purchasing power that inflation brings.
- Interest Rate Environment: The attractiveness of utility stocks is partly dependent on interest rates. When combined with investors flocking to Treasurys, it can suggest expectations of stable or falling interest rates, which would maintain the appeal of the high dividend yields offered by utilities.
- Risk Sentiment: A rally in Treasurys typically indicates a flight to safety. When combined with relative strength in utility stock prices, it may suggest a growing preference for lower-risk investments, which could bode well for the continued outperformance of the utilities sector.
The Bottom Line
Bottom line? The utilities sector’s recent relative performance, while early, could be an important signal. In conjunction with rallies in both gold and Treasurys, this may offer a unique setup that could lead to sustained success for this traditionally stable part of the market.
While it remains to be seen if this trend will continue, it’s worth watching closely. It’s usually not a good sign to see defensive areas of the market rallying stronger than the broader market after a prolonged uptrend.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
