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  • Utility Stocks: Their Hidden Message 0 comments
    Aug 2, 2013 10:31 AM

    By Michael Lombardi, MBA for Profit Confidential

    "When in doubt, look at the charts."

    The above has been my motto for years. I believe that stocks and the stock market are leading indicators. They tell us what is going to happen with specific industries, various prices and the economy six to 12 months out.

    One chart I have been studying closely this year is the Dow Jones Utilities Index. Utility stocks traditionally rise when interest rates fall and investors can get better yields off of secure utility stocks than they can get from CDs or T-bills. Similarly, when interest rates rise, utility stocks fall, as investors flee them to the rising yields of CDs, T-bills and bonds.

    But a strange thing has happened to the utility stocks. The Dow Jones Utility Index, which consists of the biggest American utilities, was trading at 210 in early 2008. As the recession hit, the government cut interest rates to record lows. The Federal Funds Rate sits close to zero.

    Historically, the utility stocks would rally as interest rates fell sharply. But the opposite has happened. The utility stocks have collapsed from a level of 210 in early 2008 to 155 today-a drop of 26%. Several times this year, the Dow Jones Utility Index has attempted to break through the 160 level, failing on each attempt.

    What does this tell me?

    If I look at stocks as a leading indicator, the pathetic performance of the utility stocks tells me that the stock market believes the government attempt to keep interest rates low (by keeping the Federal Funds Rate near zero and by the Fed buying U.S. Treasuries via QE2) will ultimately fail and reverse.

    The action (or maybe I should say inaction) of the utility stocks is a clear indicator that higher interest rates are what our future holds for us.

    Michael's Personal Notes:

    Retail sales in the U.S. missed analyst expectations "by a mile" in March, as the U.S. Commerce Department reported that sales at U.S. retailers increased only 0.4% in March-a nine-month low.

    Yes, consumers are pulling back on spending. Why wouldn't they? Real estate prices are depressed and getting worse, long-term interest rate are rising, the media coverage of "out of control" rising government debt is becoming more intense. The only things that have been rising are the stock market and precious metals. Take away government stimulus, and the stock market will lose air just like a helium balloon with many holes.

    The great majority of American consumers are living on a shoe-string budget; paycheck to paycheck. Any bump in the economic recovery will hamper consumer demand. The government knows this and this is why the government needs to keep spending, why it needs to increase the maximum amount of money it can legally borrow (now at $14.29 trillion), why it can't pull government stimulus, and why it can't raise short-term interest rates.

    Inflation-that's the real wild card here! No one really knows how all this artificial government interaction in the economy will play out for inflation. My opinion, based on what the precious metals are telling us, is that inflation will become a serious problem for the U.S. If you think that March retail sales are surprisingly weak, as they say, "you ain't seen nothing yet."

    Where the Market Stands; Where it's Headed:

    The best way to describe this market: we are close to the top of a bear market rally that started in March of 2009. I see the upside potential for stocks limited to five percent to 10%, while the market risk rises each day. Ten-year U.S. Treasuries are getting back to the 3.5% to 3.6% yield level, closing on the 4.0% yield that I predict we will surpass this year.

    The Dow Jones Industrial Average opens this morning up 6.1% for 2011.

    What He Said:

    "The Real Threat to the Economy: U.S. retail sales are falling, the producer price index is crashing, house prices, car prices are all falling-and no one is talking about deflation but me. Fed governors are still talking about inflation-they've got it wrong. There's no need for me to get into the dangers of deflation, as I've written about them (many times) before. Let's just put it this way: deflation is about the worse economic state a country will experience. The risks to the U.S. economy in 2007 are greater than I've seen in years." Michael Lombardi, Profit Confidential, November 15, 2006. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.

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