This time surging utility stocks are a danger to themselves but not the wider market

By Jamie Chisholm

Critical information for the U.S. trading day

Early Friday futures show the latest stock market rally is intact. The Dow Jones Industrial Average DJIA may register an eighth consecutive day of gains. The Nasdaq Composite COMP sits just 0.6% shy of another record.

But long-time market watchers may spy a flashing red light. It's coming from a utility sector that is the best performer so far in May, up 6.83%, and also top in the second quarter, up 8.53%, according to S&P Global data.

"The sector has been on fire," says a research note from Bespoke Investment Group.

But why may this be a problem for the broader market? Well, shares of utilities, which often carry a fair amount of debt but provide decent dividends, tend to act as bond proxies, rallying when interest rates fall. And they represent the epitome of non-discretionary spending, therefore usually outperforming when defensive plays are sought in an economic downturn.

"Utilities are starting to rally as if we have past the peak in both rates and potentially the business cycle itself," says Michael Darda, chief economist and market strategist at Roth MKM.

And as Mark Newton, head of technical strategy at Fundstrat says: "Normally, one would view an uptick in utilities as a possible warning sign, as the bear market of 2022 was directly preceded by a big lift in defensive issues throughout the latter part of 2021."

However, its time to sound the caveat klaxon. If the Federal Reserve is successful, interest rates should be falling later this year because inflation has eased sufficiently, and not because of any dramatic economic slowdown.

So, utilities may be rising on the monetary policy factor but not the defensive one. "[G]iven lack of strong relative strength in other defensive sectors like REITS and/or consumer staples, I don't feel this recent uptick in strength warrants much concern," says Fundstrat's Newton.

In fact, much of utilities' relative strength in recent months has been because of a third factor, the hope they will benefit from servicing the power centers that support the AI boom.

"[F]orecasts of these datacenters' power consumption needs have sparked some life into the Independent power producers (IPP's) like Constellation Energy (CEG) and Vistra (VST) which have swamped performance in other utilities this year rising over 80% year-to-date," says Newton.

So, it seems the signal from utilities to the wide market perhaps does not warrant concern this time.

But perhaps investors need to be wary about the utilities sector itself. Newton thinks the rally is "a bit overbought" but he still reckons the SPDR Select Utilities ETF XLU can push up to the $75-$78 range "without too much trouble."

However, Bespoke Investment is more worried about the ebullience, and provides the table below to show the extent by which the sector's surge may be overdone.

Markets

U.S. stock-index futures (ES00) (YM00) (NQ00) are higher as benchmark Treasury yields BX:TMUBMUSD10Y stabilize. The dollar index DXY is barely changed, while oil prices (CL.1) inch higher and gold (GC00) is trading around $2,370 an ounce.

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The buzz

U.S. economic data due on Friday include the preliminary reading for May consumer sentiment at 10 a.m. Eastern, followed by the U.S. federal budget report for April at 2 p.m.

Federal Reserve officials making comments include Governor Michelle Bowman speaking at 9 a.m., Chicago Fed President Austan Goolsbee talking at 12:45 p.m., and Fed Vice Chair for Supervision Michael Barr speaking at 1:30 p.m.

Shares of Apple (AAPL) are little changed after the iPhone maker felt the need to apologize for an advert that some people on social media took too literally.

Novavax shares (NVAX) are surging following a $1.4 billion investment deal with Sanofi.

The U.K. economy grew 0.6% in the first quarter of 2024, exiting a technical recession. The FTSE 100 UK:UKX hit a fresh record high having jumped 11.5% in just the last three months.

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Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

   Ticker  Security name 
   GME     GameStop 
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   TSM     Taiwan Semiconductor Manufacturing 
   AAPL    Apple 
   AMC     AMC Entertainment 
   NIO     Nio 
   PLTR    Palantir Technologies 
   AMZN    Amazon.com 
   MARA    Marathon Digital 

The chart

U.S. corporate bonds since March 2020 have outperformed U.S. government paper by the most in 100 years, as government spending has jumped 40% over the period to $6.2 trillion, notes Michael Hartnett at Bank of America.

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-Jamie Chisholm

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05-10-24 0731ET

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