The JP Morgan Guide to the Markets is out for Q2 and is always a good place to find some fun charts and a recap of
the prior quarter. I usually peruse
through it when it arrives in my inbox.
This quarter, something in particular caught my eye – in Q12013
Utilities are up more than the S&P 500 (SPX).
The sector was up 13% and the index was up 10.6%. This is odd as Utilities are typically
defensive so when SPX rallies hard like it did in Q1 you would expect Utilities
to lag. Over the last 10 years the beta
(how Utilities move relative to a move in SPX) is .52, which means since SPX
was up 10.6% Utilities should have been up roughly 5.50% based on the last 10
years of historical moves. So why did
this happen? I have two thoughts:
- Search for yield. The 10-Year Treasury floats around 1.75% with SPX around 2.00%. Utilities yield about 4.00%. This feeds into…
- Capital Protection. Investors are still nervous from 2008 and 2009. Given the low yields, investors feel more compelled to reach for yield and return in less volatile equities. This is evidenced by large moves in other low beta, defensive sectors – Health Care, Staples, Telecom – in Q12013.
This presents two questions.
The first is will these conditions persist? I think yes given QE (Fed won’t let rates
rise) and investor psychology being extremely sticky.
The second is what happens if the market reverses? Utilities are roughly 30% overvalued to their
historical norms. Thus, the risk is that
if the market starts trending negatively, the downside protection Utilities
provided in the past may not hold this time around. Though if the market moves higher and
Utilities lag this could correct itself before an overall market correction.
Thus, the conclusion I draw is that while the conditions
driving Utilities higher are still in place, I am concerned their upside
potential does not compensate for the downside risk. This kind of market disconnect can have great
bearing if there is a sudden increase in downside market volatility as the
investor could be subject to more risk than initially thought.
If decent yield with a defensive posture is a prime goal, an
investor may be better served looking at alternatives to this sector or, at the
very least, understand the risk.
Past performance is no guarantee of future results. An
investment concentrated in sectors and industries may involve greater risk and
volatility than a more diversified investment. The views and opinions expressed herein are
those of the author(s) noted and may or may not represent the views of Capital
Analysts, Inc. or Lincoln Investment.
