XLU is set up for a near-term bounce. Whether it will come or not is an open question as defensive areas of the market have arguably been the weakest cohort since the bull took chart in early 2023.
Price Action & Performance
The XLU has now retraced a majority of its April/May break-out and sits at an intermediate term support level with the daily RSI at clear oversold levels.
Breadth measures are near washed out levels with only 29% of stocks in the sector above their 50-day moving averages. Historically a reading below 25% on this study has coincided with eventual reversals.
At the industry level Electric Utilities and Independent Power Co.’s are still in somewhat clear bullish reversal patterns while Gas Utes and Multi-Utes are laggards.
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 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 trend entirely. This has led to more discounting of dovish policy in the 2nd half of 2024. Given a switch to more bullish policy expectations we expect risk appetite to increase, but with XLU so oversold in the near-term it is at least a decent candidate for bottom-fishing. In general, legacy min. vol. sectors have been the weakest areas of the bull. We are favoring XLU over XLV and XLP exposures for July based on our Elev8 model scores.
How Can XLU Help?
XLU offers a great portfolio tool for downside protection. Among the highest dividend yields of any S&P GICS sector, the XLU offers low volatility with solid yield and a capital appreciation opportunity. Its stability means it is often sought after by investors when the VIX is rising, or, in periods like today when the VIX is very low, but investors have some reason to be nervous. As a high dividend sector, it gets the “bond proxy” label very often, and historically outperforms when yields move lower, and income focused investors are forced to reach for yield.
In Conclusion
XLU has been a structural laggard since the bull market trend’s inception in early 2023. But after a surge in April and May it is now oversold and potentially buyable. Our Elev8 Sector Model continues with an OVERWEIGHT allocation to XLU of +0.98% above the benchmark S&P 500.
Chart | XLU Technicals
- XLU (200-day m.a. | Relative to S&P 500)
- XLU is now oversold and at support having been discounted back towards the relative lows of the year. It is a potential bottom-fishing candidate given the setup
Data sourced from Bloomberg
