Stocks have rebounded from a weak April, led by two sectors that typically outperform during economic downturns.
Since April 16, when the S&P 500 (^GSPC) hit its most recent low, utilities (XLU) have led the charge, rising nearly 12%, accounting for all of the sector's year-to-date gains. Over the same period, consumer staples (XLP) stocks rose about 5%, while the S&P 500 index rose about 2.7%.
Wall Street strategists said the two sectors are likely to catch up after dismal performance in early 2024.
Keith Lerner, Trust Co.'s co-chief investment officer, said the move simply reflects investors' desire to capitalize on recent market gains, given that both sectors were the worst performers on the S&P 500 last year. It was inferred that there was an aspect of them simply shifting to fields in which they were not yet very involved. .
The utilities sector entered March at the largest discount to the S&P 500 since 2009 from a valuation perspective (using forward price-to-earnings ratios), Lerner said. Meanwhile, Consumer Staples underperformed the S&P 500 by nearly 30% last year. This created potential buying opportunities in both traditionally “defensive” sectors.
“People are getting anxious because the market is up as much as it's been since October,” Lerner told Yahoo Finance. “They want to be a little more defensive and try to take profits…It's also about 'what went wrong, what's the opportunity to catch up to the market or hold up better?' It's also just saying 'Is that correct? '”
Over the past month, there have been clear fundamental factors why utilities are bidding. The segment's profit increased by 26.7% in the current quarter compared to the same period last year. That's the second-highest growth rate among all sectors, according to FactSet. There is also growing discussion about how growing interest in projects involving artificial intelligence and electric vehicles could boost electricity demand for companies in the utility sector.
Several macrocatalysts are also at work. The rise in the interest rate-sensitive utilities sector came as investors digested the Fed's message last week that further rate hikes were unlikely. This lowered the 10-year Treasury yield (^TNX) by about 20 basis points from its 2024 high, providing a reprieve to a sector that typically fell as yields rose over the past year.
Another important development is in economic indicators. After economic growth continued to surprise Wall Street at the start of the year, April's data improved, with weaker-than-expected jobs numbers and a contraction in manufacturing activity that month.
This doesn't mean the U.S. economy is definitely slowing down, but it's getting investors' attention. Mike Wilson, Morgan Stanley's chief investment officer, said in a weekly memo to clients on May 5 that if manufacturing data continues to be weak, investors should “focus on defensive sectors such as utilities and consumer staples. “You might want to consider your exposure a little bit.”
But the rise in utilities and consumer staples won't necessarily continue.
Kevin Gordon, senior investment strategist at Charles Schwab, told Yahoo Finance that looking at what has led the market since the beginning of March, there are multiple different stories at play, so a defensive strategy has staying power. “I don't know” whether he will have one, he said. Gordon said the rise in Communication Services (XLC) over the past few months shows a trend toward growth. Energy (XLE) will be cyclical. Meanwhile, recent gains in utilities suggest a defensive stance.
All three sectors were top performers on the S&P 500 this year.
“It doesn't send me a clear message about whether the market is risk-on or risk-off,” Gordon said.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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