US stock cycle is now at ‘Early Bear’ to ‘Middle Bear’ based on these reasons
YTD price performance of sector-based exchange traded funds or ETFs indicates US investor-emphasis on utilities indicating of risk aversion, flight to safety. Traditionally this puts the stock market-economy at early to middle bear market, entering recession soon.
Utilities as a Safe Haven
Historically, utility stocks have been known for their defensive characteristics. That is, when the stock market is weak, they usually outperform the broader market averages. Conversely, they are laggards in bull markets.
The biggest reason for the greater stability of utility equities is their generous dividend payments. In early November of 2011, the average electric utility issue yielded 4.3%, and the average gas utility equity yielded 3.7%. A high dividend yield often lessens a stock’s downside risk. In addition, utilities have less exposure to economic cycles than most other industries. Residential electric usage fluctuates largely due to weather patterns. Gas and water utilities have less sensitivity to the economy than electric companies.
How does the risk of investing in the utilities sector compare to the broader market?
The risk of investing in the utilities sector is less than the broader market. The two main reasons are the high dividends in the utility sector and its relatively recession-proof business. While risk is decreased in the utilities sector, it is also likely to underperform the market during bull markets. Due to this behavior, utilities are considered the ideal defensive sector. Utility stocks tend to perform best late in the business cycle when growth begins to slow and during periods when interest rates are declining.
Defensive sectors tend to outperform when investors become concerned about a slowing economy. Utility stocks’ revenues are not affected by changes in the economy, and their high dividends become appealing when downside risks accumulate. Further, central banks respond to a slowing economy by cutting interest rates, which is a positive catalyst for dividend-paying stocks.
Traditional performance, stage of cycle
- The stock market cycle (blue) has topped, passing the ‘Early Bear’ stage.
- The economic cycle (yellow) has topped, moving towards recession (see GDP).
ETFs That Outperform in Late Stage, Recession, and Trough | Source: Market Realist
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Soh Tiong Hum is Director of TerraSeeds Market Technician Pte Ltd. TerraSeeds is a trading educator in Singapore since 2005.
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