Utilities and basic materials were last month’s weakest sectors according to FINVIZ.com, down 4% and 6% respectively. So far in 2015, the market’s strongest sector is healthcare, up 12%. Utilities are the year’s weakest, down 8%. What does this mean for the markets?
Utilities are particularly sensitive to interest rates. They are stocks that trade in sympathy with bonds. Historically, this correlation with bond prices has made utilities a statistically measurable, if quite weak, predictor of the overall direction of the stock market. This does not prove the overall market is necessarily destined to fall, however. Utilities displayed similar weakness two years ago in the middle of 2013, and the S&P 500 has returned 30% since that time.
We said before that the S&P 500’s 14% return last year was doubly impressive because it happened while the U.S. dollar was simultaneously mounting an historic rally. The dollar has spent the past four months moving sideways, showing no inclination to either give up its 2014 gains nor to extend them further. If the dollar does give back a little ground, stocks should do okay because it will be easier for U.S. companies to report better dollar-denominated growth. Conversely, if the dollar rallies even more from here, this probably signals that the world economy is weaker than generally believed. U.S. equities may not do well in that case, but we’d rather own them than foreign assets.
Valuations may be a little stretched, but we still see opportunities to make money in the stock market. We can’t say the same of bonds for the most part. Hiding out in cash does carry some allure, but holding too much cash at the expense of productive assets can be risky in its own right. What if we’re wrong that inflation will not run too hot? Remember that stocks represent ownership in a business, and solid businesses are real assets. A reasonably diversified portfolio of such should produce a solid real return over time. That kind of confidence is hard to find anywhere else in the global financial markets.