Look Out Below! This S&P Sector Could Drop Up to 46%
While a fairly violent counter-trend rally has brought the market back to where it was a month ago, the sectors that helped keep stocks on their feet may start paying a price.
Most notably, utilities have been the second-best performer on the Standard & Poor's 500 since the stock marketpeaked on April 2.
The group has gained about 5 percent in a time period where the index itself has fallen nearly 6 percent. But that could be about to end.
Depending on who you talk to, utilities could be on their way either to a mild pullback or a long slide down — as much as 46 percent, in fact, according to one bearish forecaster who sees major technical problems ahead.
Using the sector's exchange-traded fund proxy, the SPDR Utilities, Abigail Doolittle at Peak Theories Research believes the sector has put in an ominous double-top on the charts.
"It seems that the safe, easy, 'sure thing' trade of 2012 also known as the XLU is about to get a little less safe, easy and sure and this suggests two things: first, there’s nowhere to hide in the risk-on trade and second, there’s something to hide from," Doolittle said in her analysis.
Tracing the ETF's three-year trend shows a likelihood that utilities are now likely to hit the bottom of an ascending trend channel — essentially the upward range in which a security trades, drawn between two parallel lines.
Incorporating other events — the May 6, 2010 "Flash Crash" for one — Doolittle finds the ETF in a rising wedge pattern, an often-bearish signal in which a security rises in a wide range near the bottom and then tightens once it gets higher.
All of it adds up to a reversal in which the XLU could lose as little as 10 percent or, in what she considers the more likely scenario, 46 percent down to the $20 range.
"What makes all of this so interesting is that this so-called bear market sector has performed as it should — well — through the recent market turmoil...but now it seems that it, too, may fall to investor uncertainty about the euro zone crisisand worries about the true health of the global economy," Doolittle said.
Concerns about utilities also focus on how pricey the defensive sector has gotten during its stalwart performance.
Utilities now have the third-highest price-to-earnings ratio of the 10 S&P 500 sectors, trading with a 15.3 multiple, according to S&P/Capital IQ. That puts it ahead of financials, energy and even tech. Utilities and telecom both have surged during the period.
"These sectors rarely make big moves on a day-to-day basis, but they’ve been experiencing outsized gains consistently since the start of May even as the overall market has been weak," said Paul Hickey at Bespoke Investment Group. "This type of rally can’t go on forever, however, and we recommend lightening up on these two sectors if you’re overweight."
S&P strategists Sam Stovall and Mark Abeter both have warned that the market has sustained some technical damage that will take time to iron out.
"We see some indicators hinting that the coast may be clear, while others indicate that choppy market action may be with us for a while longer," Stovall said.