Executive Edge

This defensive sector is market's best right now, and history suggests more gains are coming

Key Points
  • Utilities stocks are now the top sector in the S&P 500 for January.
  • Fears about a global pandemic, sparked by the Chinese coronavirus, are sending more investors into a defensive portfolio position.
  • Recent trading history for the utility sector shows that when it surges, the gains continue for at least another month.
Utilities sector is hot and it may not cool off

Investors are playing more defense with their stock market portfolios. Even as stocks rebounded on Tuesday, history suggests that a good defense may continue to be a good offense over the next month.

The move into risk-off stocks is highlighted by the strength of utility stocks, now the best-performing sector of 2020. The move into utility stocks began before the Chinese coronavirus hit the markets hard, but has accelerated since fears of a global economic slowdown ticked up on fears of a pandemic. A CNBC analysis of recent trading history suggests that the utility sector should continue to benefit from a more risk-averse market.

The utilities sector has been soaring. Over the past month, the SPDR Utilities ETF has jumped more than 6%, and it is on pace for its best month since June 2016 and has taken over the top spot from information technology for the month of January.

According to hedge fund analytics tool Kensho, the defensive trend should continue for at least another month.

Over the past five years, the XLU has had similar gains on six other occasions. A month later the positive momentum tends to continue. The XLU gains nearly 1%, trading positively 83% of the time — and it outperforms the S&P 500 during these periods.

Six out of 11 sectors in the S&P 500 are still positive for 2020, led by utilities, which is up 5.6%. The information technology sector is up 3.8% for the year, with the coronavirus related to losses in Apple — it manufactures phones in China, and the country has become its most important sales market — contributing to its recent weakness.

Todd Gordon, founder of TradingAnalysis.com, told "Trading Nation" on Thursday that as bond yields have declined — with investors seeking safety driving up bond prices — high-dividend utilities gain. "We're moving lower here in the 10-year yield following a very clear correlation of declining yields and strong utilities," he said.

Gina Sanchez, CEO of Chantico Global, added that she does not see a reason why the utilities sector will break down, even with its valuation high by historical standards.

"They're great payers; they're not supposed to be at multiples of 21 times," Sanchez said during the same segment. "And yet that's where they are, and yet their dividends are still almost 3%, they're still the third-highest-paying dividend sector in the S&P."

Other market watchers are concerned about both the risk-on and risk-off stocks that have led the market.

"There are five technology names that are driving a good chunk of the movement in the S&P. On the other side, you see the utilities index," Art Hogan, chief market strategist at National Securities, recently told CNBC. "The index is trading at 25 times, and it's throwing out a dividend that's less than 3%. Both of those numbers are historically stretched. This is an index that usually trades at 16 times and has about a 5% dividend."