Utilities have been one of the bigger beneficiaries of the growing risk-aversion globally, accelerating to fresh highs. Tactically in the near-term, this recent move has pushed the sector back into overbought territory on a few different metrics (e.g. 1-months highs > 75%, RSI), and suggests that a period of modest consolidation (2-4%) is likely. While I remain encouraged by the uptrend in place, what has really caught my eye, has been the base that the sector has been tracing out over the past year on a relative basis versus the overall market. With the consensus continuing to call for a breakout in rates, one has to wonder what the relative is sniffing out.
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Utilities and REITs have spent the past week digesting their recent overbought conditions, a process that has been facilitated by the snap back in yields from 10-month lows. We’ll see what this week’s Fed meeting provides, but yields remain range bound with a downward bias in our view. Utilities continue to possess the stronger trends of the two, with each of the sector’s industries firmly in an uptrend. Strength in REITs on the other hand is not as ubiquitous, with areas such as Diversified, Industrial, Residential and Specialized continuing to carry the leadership baton. Unfortunately, the same cannot be said of those operating in the retail space, as the battered sub-industry is off nearly 30% from last summer’s peak. We have received a number of question on the space and for the first time in months, there looks to be a sliver of hope on the horizon. Not out of the woods by any stretch, but as the chart below illustrates, I’m encouraged with the 5-month base that the group has been carving out. An acceleration through resistance, which also happens to correspond with the 200-day, would be an important victory for the bulls. They still have plenty of work to do, but ADC, NNN, O, BFS and UBA are a few that are further along in the healing process.
Oversold entering Yellen’s testimony yesterday (7/12/17), Utilities and REITs enjoyed her more dovish tone, as rates pulled back near resistance. Any way you slice it, both groups were oversold, but with sentiment around rates a significant driver in the shortterm, now the real work begins. As we have always discussed, how you respond to an oversold environment is critical. In an uptrend , these backdrops should be met with bullish momentum, breadth and relative performance, it’s when these attributes are absent that our concerns begin to grow. Trends would favor utilities over real estate, as select areas such as retail and office continue to languish within REITs.
From a macro perspective, two charts are pretty much all you need to understand the dynamics driving the groups in today’s piece. The first chart is that of 10-year yields, and the tailwind it has provided for Utilities, and to a lesser extent REITs. Utilities are digesting their overbought condition, but if the distributive nature of the 10-year continues to resolve itself to the downside (which looks likely), this period of consolidation will likely be short-lived, giving way to the healthy trends underlying the sector. REITs broadly have not enjoyed the same momentum, but select sub-industries sure have. Diversified, Hotels & Resorts, Industrials, Health Care and Residential are a few that possess the attributes we favor, and we’ve included some of our favorite charts within each.
While equity trends continue to be constructive, catching up on the charts over the past few days, one thing in particular really caught our eye since we last published a little over 5 weeks ago...the bond market. While yields are fighting the good fight at 2.15% support, the curve has collapsed, and is now the flattest it has been since October of last year. Growth as a style had clearly become extended versus value, and while a reversion in both is to be expected, we have a tough time believing that value can post meaningful absolute and relative performance without bonds cooperating.