The good days for Utilities and Real Estate Investment Trusts (REITs) in the US markets might have come to an end. In 2014, driven primarily by lower interest rates and investors’ thirst for higher yields, both sectors outperformed the broader market (S&P 500) by more than 15%.
Two consecutive positive job reports however devastated both sectors as investors expect interest rates to rise sooner than later. As interest rates are expected to rise, the dividends on these sectors become less attractive. The latest report was released on Friday when the unemployment rate decreased to 5.5% in February from 5.7% in the previous month. It was the lowest figure since May of 2008. The news immediately sent a shock wave to Utilities and REITs which saw their prices drop by more than 3% – double the broader market drops.
In our Technical View article back in December we warned investors regarding the potential risks of Utilities despite their rising performance. The below is a direct code from the article:
“We believe that the search for yield was the main driving force behind this outperformance but caution is recommended ahead. When interest rates start rising, they can erode some of the advantages that utility stocks have enjoyed so far this year”
Looking at the Utilities Sector chart below it is clear that the long term trend line has been violated to the downside and a medium term Dow Pattern (Lower Highs, Lower Lows) is now in place. In both instances the price failed to move above support levels S1 and S2. At the same time volume confirms the downtrend as it expands on down-legs and contracts on pull backs.
REITs as measured by the Vanguard REIT ETF have had a similar reaction over the last two months. A medium term downtrend is now in place. The ETF has seen its price drop by 3.3% on Friday following the positive news on jobs.
Looking at both sectors relative to the S&P 500 it is evident from the below chart that their outperformance has reached a dead end. Note that the chart below uses a Relative Strength line, a technical concept which divides the performance of the sector vs the S&P 500. A rising RS line indicates that the sector is outperforming the index and the opposite happens when it’s falling. Both sectors have seen their RS lines dropping below the September uptrend, which possibly indicates further underperformance ahead.
On the other side of the spectrum, another interest-sensitive sector is having an opposite reaction to the recent economic news. Financials have recently struggled with the uncertainty regarding when interest rates will start to rise, as the decline in longer-term rates has posed a threat to interest income. But as the economy picks up, the potential for a long-awaited reversal in bond yields grows and that is promising for the financial sector in general. The chart below shows the Relative Strength line of financials vs the S&P 500. The interesting part is that it is holding above support line with a potential to move higher. The RSI Momentum Oscilator, which measures the strength of the trend has moved into bullish territory. Both technical factors are promising for the sector. However we have to emphasise that there is no clear relative uptrend at the moment so investors might want to wait before jumping in.
As the economy picks up steam the probabilities of an interest rate hike are increasing. Interest-sensitive stocks like Utilities and REITs have already started to discount this development and as a result their shares have started to underperform the broader market. On the other hand, financials who thrive on higher interest rates have started to show signs of life. So our advice for investors is to stay away from Utilities and REITs and closely monitor Financials for a possible entry.
Costas Pierides CFTe MSTA
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