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The hottest trade of the year could get hotter

The hottest trade of the year could get hotter

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The hottest trade of the year could get hotter

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This sounds like good news for stocks--but it isn’t

This sounds like good news for stocks--but it isn’t Up next

This sounds like good news for stocks--but it isn’t

As the market approaches new highs in 2014, it was—and still is—a great year for utilities. But has that sector’s run come to an end?

The ETF tracking the S&P 500’s utilities sector, XLU, was up 16.6 percent for the first six months of 2014. Yet since the start of July, the XLU is down 4 percent. Some of its bigger names like Exelon and NRG Energy are down more than double that this month.

With the XLU now down from its all-time high of $44.36 per share made just a couple of weeks ago, is it running out of power?

Gina Sanchez, founder of Chantico Global, believes investors should watch interest rates.

While the recent run “was really buoyed by a very harsh winter [and] high gas prices … there were these ruminating concerns that a rise in interest rates could maybe knock them off their perch,” said Sanchez, a CNBC contributor,

(Read: Treasuries flat on steady policy message from Fed's Yellen)

The sector’s dividend yield is 3.7 percent compared with the benchmark U.S. Treasury 10-year note’s 2.54 percent yield. That helped make utilities attractive to investors, especially because it also meant utility companies can borrow at lower costs, said Sanchez.

“The fundamentals for utilities are still actually quite solid,” Sanchez added. “They have very good earnings power and their balance sheets have gotten stronger. Now, much of that is that they have been borrowing at low rates. So I think you do have to keep an eye on interest rates because that will matter to the utilities story.”

According to Ari Wald, head of technical analysis at Oppenheimer & Co., it’s not just enough to look at a chart of the XLU alone, or absolute basis. Instead he’s also looking at a chart of the XLU on a relative basis to the S&P 500 by dividing the former by the latter and charting the results.

(Read: Wall St pulls back on Yellen's comments on valuations)

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“Here’s what’s amazing about the XLU,” Wald said. “On an absolute basis, you’re right there to where we were back in 2007; the highest level since then. But relative to the market, you’re actually coming off your lowest levels versus the S&P 500 since 2004. So we think it’s just so important when talking about utilities whether we’re talking about on an absolute basis or relative to the market.”

Wald believes the XLU will move higher toward $44.50, which he sees as resistance. “The short interest is still pretty high on XLU,” he said. “So, we think the surprise comes to the upside. We think it does move higher.”

On a relative basis, however, Wald has some concerns. “That relative trend is positively correlated to rates,” said Wald. “Just speaking strictly in terms of the trend, until that can really base a little bit further, we think utilities is a market underperformer at best.”

To see the full discussion on utilities, with Sanchez on the fundamentals and Wald on the technicals, watch the above video.

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