Relative Strength in Utilities ETF May Be Deceptive

| About: Utilities Select (XLU)

Utilities have been among the few sectors with high relative strength during this recent swoon that began in May. Usually this would make me like the sector because by swimming upstream against the current, it is showing that the ’smart’ money has spoken. But there is more to it when you look beneath the surface.

For one, the breadth in the sector makes the probability of a continued rally very low. Right now, 100% of the constituents of the utilities ETF (NYSEARCA:XLU) are trading above their 50 day moving average; as well, more than 90% of them are trading above their 200 day moving average. Much like a sprinter after a mad dash, the sector is out of breath having exhausted itself in this recent run up. The best thing that we can hope for is a pause. A fall from these heights is also possible since the sector is up to an old resistance that has pushed it back since August of 2005.

Another reason why I’m suspicious of the sector’s relative strength is that it is not the ’smart’ money that has been buying utilities. Looking to the Rydex utilities sector fund, its assets have swelled from a paltry $10 million from just a few months ago to almost $100 million today. Obviously the retail, Mom’n'Pop investors are crowding into this sector like crazy. Maybe their rational is to take refuge into ’safe’ stocks, maybe they are mo-mo investors who are simply buying because it has gone up, maybe they think the interest rate cycle has peaked… who knows.

All I know is that they are the crowd to fade not emulate. In fact, the last time the Rydex crowd got this excited about the utilities sector fund was back in July 2005 (first red circle). The other times were September 2000 and February 2001. Both great long to intermediate sell signals.

Although I don’t think the utilities are an automatic short here, if you’ve got any, it is prudent to look for exits and tighten stops.

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