If History Is Any Guide, You’ll Want To Pay Attention To Utilities’ Hot Start To 2024
Are You Sure It's A New Bull Market?
After going on a holiday buying spree to wrap up 2023, it looks like investors might be checking out the return policy on some of their purchases.
Over the past two weeks, there’s been a fairly strong sentiment shift back towards defensive strategies. Some of that may be due to a simple retracement of overbought conditions related to the Fed pivot trade or it may be something more. Since traders returned on the day after Christmas, utilities are outperforming the S&P 500 by more than 4% and the Russell 2000 by nearly 7%. Value, low volatility, dividend and consumer staples stocks haven’t been quite as successful as utilities, but they’re also beating the major averages by a sizable margin over the same time frame.
The million dollar question, of course, is whether or not this momentum is sustainable. The markets like to talk about the January effect around this time of year that holds that a strong start to the year often leads to positive returns for the year as a whole. That’s been studied pretty thoroughly with regard to the major averages, but I wanted to see if it applied to relative outperformance as well. If utilities are beating the S&P 500 to start the year, will they outperform for the full year?
You probably already know that I believe utilities could be a breakout sector in 2024. Whether it’s fundamental considerations, such as valuations, or falling interest rates or the risk of deflation, utilities have plenty of potential catalysts that could play out this year. It’s early, but the outperformance of utilities over the past couple of weeks has coincided with the rebound in interest rates. If this trend continues, the utilities rally could have legs.
So let’s take a look back at the performance of utilities and the S&P 500 to see if this thesis has any history to back it up. Since utilities is simply one of many potential defensive equity strategies that could be considered, I also want to take a look at consumer staples and healthcare. Both of these sectors tend to behave tangentially similar to each other, but there are enough differences that they can also behave independently of each other for extended periods of time as well.
For this analysis, I’ll use four ETFs as proxies - the SPDR S&P 500 ETF (SPY), the Utilities Select Sector SPDR ETF (XLU), the Consumer Staples Select Sector SPDR ETF (XLP) and the Healthcare Select Sector SPDR ETF (XLV). All four have history going back to at least 1999, so we’ll have about two dozen different examples with which to draw conclusions from. For the “first week”, I’ll simply consider the 1st five trading days of the year. We’ll look at the total return for those five days and then put it side-by-side with the full year calendar return to see if there’s a correlation. Make sense?
Let’s take a look at some numbers!
I have the years 1999-2023 ranked according to utility sector outperformance to start the year. In those 25 examples, only 6 years saw utilities leading the S&P 500 out of the gate (and in two of those 6 instances, the outperformance was negligible). Overall, the results on a year-to-year basis are kind of all over the place. Of the three years that utilities led strongly to start the year, only one of them, 2008, saw utilities add on to that outperformance. In the 7 years that utilities led the S&P 500 by more than 10% for the full calendar year, only 2022 saw utilities getting the early jump.
On the other hand, utilities ended up underperforming the S&P 500 in most years that it lagged to begin with. In many cases, it ended up lagging further as the year went on. That produces a scatter plot that looks like this.
The blue dots are utility sector outperformance in the 1st five trading days in order, just like the table. The red dots are the performance relative to the S&P 500 for the full calendar. The trendline shows that there is a positive correlation between utility sector outperformance to start the year and utility sector outperformance for the full year. There’s a lot of volatility in the year-to-year results though and I don’t think it’s necessarily something that should be bet on given its history.
The consumer staples sector, however, has produced more reliable results.
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