- For the past few weeks, there has been an unrelenting short-term surge in relative strength of the Utilities sector relative to the S&P 500.
- Because Utilities are the most interest rate sensitive part of the stock market, the sector’s movement can tell you a lot about shifting expectations on growth and inflation.
- The remarkable yield curve flattening of 2s and 10s (largely driven by short-term rate movement) is happening on a part of the yield curve the Fed has far less control over.
"History is a vast early warning system." - Norman Cousins
It would seem that something is wrong.
For the past few weeks, there has been an unrelenting short-term surge in relative strength of the Utilities (XLU) sector relative to the S&P 500 (SPY). The move has been abnormally sharp in the face of a US market which has gone sideways, and a Treasury market (TLT) steadily creeping towards lower yields.
The significance of the move in Utilities matters a lot for us at Pension Partners and our ATAC Tactical strategies run in mutual funds and separate account format. As documented in the 2014 Dow Award winning paper, Utilities tend to outperform on a short-term basis when conditions begin favoring a potential accident in markets. Because Utilities are the most interest rate sensitive part of the stock market, the sector’s movement can tell you a lot about shifting expectations on growth and inflation. That in turn means their movement can be a warning sign that we are about to enter into a risk-off period.
There is confirmation happening in bonds as well. Long duration Treasuries on a short-term basis are also outperforming intermediate. The remarkable yield curve flattening of 2s and 10s (largely driven by short-term rate movement) is happening on a part of the yield curve the Fed has far less control over. As shown in our 2014 NAAIM Award Winning paper, this also tends to be a warning sign of conditions favoring an accident.
Emerging markets (EEM) have been in a severe correction since the peak this year, and it isn’t a story just about China (FXI) or tariffs. Plenty of countries unaffected by policy are feeling the pain. Now, US markets may end up “catching down” to emerging market weakness. As Charlie Bilello noted, the Dow Jones Industrial Average (DIA) closed below its 200-day moving average for the first time in two years, suggesting higher volatility and tail risk may present itself sooner.
Bottom line? Something is bothering the market. Several volatility warning signs are flashing at the same time. If the start of the year has largely been dominated by the narrative of small-caps being the only place to be, the middle part of the year may be dominated by a bond market showing the world that the rising rate narrative is, by no means, a guaranteed one.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
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