US stock investors doing that ‘flight to safety’ last week
Utilities outperforming a risk aversion signal
Exchange traded fund XLU was best performer among it’s peers last week. Over a 1-day (24 February 2017) and 5-day duration (Week 8, 2017), XLU was best performer among a stable of SPDR http://www.sectorspdr.com/sectorspdr/tools/sector-tracker S&P500 sector tracking funds.
Why Utilities? Why bearish?
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.
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.
We saw such similar performance last year.
2016 was a horribly volatile year. Despite year-end excitement pushing major stock indices to new high in November and December, it is clear that Utilities was leading most of the time.
In fact based on this chart below, Utilities did well over January and February 2016 when the overall stock market was at it’s worst. Utilities also did relatively between during the Brexit period. We can see that when the market turned out to be most bullish following the November Presidential Election, Utilities pale in a relative manner.
Buying into Utilities?
It may be too soon to be alarmed but most recent action on the right hand side of that chart indicates that Utilities and the S&P 500 might be parting ways.
I don’t want to be playing Auld Lang Syne at a such an exuberant level but it pays to keep an eye on. After all, fire drills are irritating, false alarms are worse but the best alarms are those that sound before you see a fire, not when you are looking at one. And to think positively, how can one buy stocks at discount if they don’t correct?