As I said last time, we are watching the utility sector for clues about the future course of stocks overall. The good news is that last week the Utility Sector (XLU) made a new 2010 high. The not-so-good news is that its price did not exceed the December 2009 high.
Utilities are a key indicator because they possess two important qualities.
History shows us that they usually lead stocks out of bear markets and corrections.
They are in the category of bond-like stocks that has been doing very well in recent months.
The bond-like qualities of utilities may be the most important indicator in the current market. Bond prices continue to surge, with the 10-year T-bond now yielding under 2.5%. By contrast, the current dividend yield of the utility sector (XLU) is approximately 4% and, according to Bloomberg, has produced dividend growth of over 5% per annum over the past five years.
I was modestly disappointed that XLU did not pop north of the December 2009 high in last Friday's big up move. However, hot markets do not usually draw lots of investors to the slow-moving utilities; thus perhaps Friday's action should have been expected.
Another reason I am so interested in the utilities is that they are widely owned by individual investors. A continuing uptrend in XLU would suggest that individuals may be accumulating their old faithful sector. The other old-faithful dividend sector, banks, has completely betrayed the individual investor with dividend cuts and continued turmoil.
If the utilities keep moving higher and break above their old high, it would not stretch the imagination to think that they might continue to move higher than most people now believe. The reason is simple: There are not many sectors of the stock market that have treated long-term investors very well in recent years. The old favorites, health care and banks, have both let investors down over the last decade. Only the utilties have provided a solid return during this time.
Our Dividend Valuation models are suggesting that utilities are as much as 25% undervalued. Maybe just maybe, this industry has it affairs enough in order that they will pierce their 2009 highs and break into new territory. That is what we are counting on.