Post by MAPsignals | Commonstock | MACRO: Utility Stocks’ Power Surge Risks a Short Circuit

Utility stocks have been on an epic AI-fueled run in anticipation of a secular increase in electricity demand. The sector is up 10.1% over the last 3 months, easily beating the S&P 500’s 5.9% total return (chart).

The AI rally has been breathtaking.

In the technology and communications services sectors, the big gains are justified. After all, the AI build-out is helping drive market-leading, high-teens earnings growth for big tech.

But it’s going to take time for AI to drive big fundamental improvements elsewhere, especially in the heavily regulated utilities sector.

Electricity demand may be rising, but so are the costs of upgrading our rickety power grid. And the government gets to sign off on regulated utilities’ pricing.

They can’t just charge whatever the market will bear like companies in other sectors.

Here’s the takeaway: The bullish consensus on utilities is too simplistic. Assuming AI drives increased demand for power, that won’t necessarily translate into surging profits for regulated utility providers.

At MAPsignals, you know we follow the data.

History is another reason to ring the register on the utilities rally.

Since 1962, quick bursts of 3-month utility sector outperformance over the S&P 500 have been followed by 2.5% of relative underperformance over the following 12 months.

In other words, don’t expect the leadership to keep up with the prior pace. The market tends to pull the plug on this non-cyclical area after these monster moves.

Check out this chart:

Step one is knowing what to expect going forward.

Step two is knowing where else to deploy those dollars.

What This Means for Your Portfolio

OK so it’s time to take profits in utilities. Here’s what to do with the proceeds.

First off, keep it simple. Buy the S&P 500.

It turns out the S&P 500 does best following top quartile, 3-month utilities sector outperformance like we’re seeing now. The S&P 500 averages a healthy 9.5% 12-month gain following big rips in utilities.

Check out this next chart:

Clearly the market keeps powering higher after these utility spurts.

Don’t cash out of stocks.

But let’s dig deeper to see which sectors look best.

We’ve been fans of cyclicals and tech for a while and we’re sticking with that call. That’s where institutional buying is the strongest.

Check out MAPsignals’ latest equally weighted sector rankings that cut across large-, mid- and small-cap stocks. Tech and cyclicals including energy, industrials, financials and materials round out our top 5:

These areas have strong tailwinds going forward including: the AI chip buildout, water management & the industrial infrastructure construction themes, and the beneficial economic stimulative effects of a Fed set to cut interest rates soon…and others.

These focus areas are brimming with big money inflows on our weekly Top 20 report, revealing the equity leaders of tomorrow.

Lastly, we sent out additional bearish Utility sector studies to our PRO subscribers a month ago right when the crowd was dazzled by their relentless charge.

Click here to review that research note.

Essentially, we saw extreme buying in the sector. To quote that prescient study from May 10th:

Now, why are we concerned about a pullback in the hottest sector? It comes down to extreme buy levels. The last week has seen a double-digit number of utility stocks get bought. This is rare action.

Below showcases the massive inflows the past week with white circles of prior similar episodes:

This was followed up with the following historical study that is relevant for today’s post.

As a reminder, the last time we saw forced selling in Utilities, we made the non-consensus bet that they would rally hard. Boy did they.

Today’s message points to near-term weakness likely ahead for the utility group. Since 2013, whenever 15 or more utility stocks are bought in a day, the forward returns for $XLU is negative 1 and 3 months later.

Even more interesting is the lackluster average performance the rest of the year post these rare inflow days:

Based on the evidence, utility stocks’ power surge faces a short circuit.

Never fight overbought conditions!

Let’s wrap up.

Here’s the Bottom Line

Utility stocks have been on an epic AI-fueled rip in anticipation of a secular increase in electricity demand.

But it’s going to take time for AI to drive big fundamental improvements in the heavily regulated electric utilities sector. The need to upgrade our rickety power grid will take decades and cost tens of billions of dollars.

History is another reason to ring the register on the utilities rally.

Since 1962, quick bursts of 3-month utility sector outperformance over the S&P have been followed by relative index underperformance over the following 12 months.

Throw in extremely overbought conditions and you’re staring at a much-needed cool down period.

But rotate into the overall market. Even better, roll into tech and cyclical areas like energy, industrials, financials and materials.

Take it further. Single stock picking is where we excel…by simply following big money flows into the highest quality stocks.

If you want to find specific large-, mid-, and small-cap names ramping with Big Money support, get started with a MAPsignals PRO subscription. It’ll get you access to our portal that updates every morning, showcasing the exact tickers being bought and their scores.

Our prized Top 20 list is full of cyclical market beaters. This is the report that found every winner in our research.

There are plenty of ways to deploy those Utilities profits. Use a MAP for navigation.

Invest well,

-Alec Young

MAPsignals

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