Price Action & Performance
The XLU peaked at the beginning of August when equities finished a sharp correction. While they have faded some since then, they ended the month firming up and look like they have potential to resume their now 6-month outperformance trend if the present macro conditions persist.
Oscillator work is near-term overbought for the sector, but it’s the broad based 6-month bullish reversal that has our attention in a positive way. The XLU has outperformed by > 10% since February and has more potential ramp as the sector has been deeply out of favor over 3 and 5yr periods.
At the Industry level we’ve seen fairly uniform improvement with the exception of the Independent Power Industry which remains somewhat uncorrelated to the rest of the sector. Relative performance over the past 6 months has seen all 5 industries within the sector outperform the S&P 500. After years of discounting, we think there may be more upside.
At the stock level our favorite names are CEG, NRG and VST. We would caution that Utilities are not historically a good source of alpha generation in bull markets, but they are tactically interesting because of the reflation dynamic as well as any potential for equity correction at the index level.
Economic and Policy Drivers
Since inflation emerged as the Fed’s most prominent threat, markets have been caught in a feedback loop comprising “a strong underlying economy à manifestation of marginal inflation à Fed talk of policy tightening à corrective action as investors contemplate a higher probability of recession/late cycle which discounts the market in the near-term à investors start to see opportunity and start bidding higher again”. There is evidence that the loop is now changing as inflation has continued to be stable and economic drivers of inflation like low unemployment, high wages and high input prices have weakened or changed the trend entirely. This has led to more discounting of dovish policy in the 2nd half of 2024. A switch to dovish policy expectations has been invigorating all laggard sectors in the near-term including XLU. As election season emerges as a driver of markets, increased policy and outcome uncertainty will likely benefit min vol. sectors like Utilities in the near term.
We like Utilities as a hedge against potential downsides in Growth sections of the market. The bull trend has been strong, with the S&P 500 appreciating well above its long-term expected return in 2024. With the intrinsic uncertainty of Presidential Election season upon us we see Utilities as useful add to the portfolio.
In Conclusion
XLU is likely to be useful in September as increasing uncertainty around the election may cause continued rotation and/or correction in equities. Our Elev8 Sector Model continues with an OVERWEIGHT allocation to XLU of +1.38% above the benchmark S&P 500.
Chart | XLU Technicals
- XLU (200-day m.a. | Relative to S&P 500 | MACD | RSI)
- XLU has been tracing out an intermediate-term bullish reversal over the past 5 months after lagging materially over 3 and 5yr periods. We like this setup for the sector
XLU Relative Performance | XLU Industry Relative Performance | 6m
Data sourced from FactSet
