#$vpu

Utility stocks have been conforming very reliably to charting analysis; if that trend continues, the chart says they better stop dropping now.

We’ve discussed in the past that most technicians or chartists have a handful of stocks, indices, tickers, etc. that never seem to behave the way they’re “supposed to” according to the analysis. For me, one such miscreant has always been utilities stocks -- the Dow Jones Utility Average, to be precise. The DJU always seemed to zig when I thought it should zag, and vice versa. For that reason, its recent behavior has been exceedingly interesting. That’s because, for about the past 6 months, the DJU has behaved exactly how our technical road map would suggest it should.

It started in March when the DJU began a healthy 12-week consolidation at the level of its January 2015 all-time highs near the mid-650′s. That was followed by a textbook breakout to new highs. The breakout would see follow-through into early July, when we noted on Twitter and StockTwits (follow us on both: @JLyonsFundMgmt) that the DJU rally was hitting the vicinity of 2 noteworthy Fibonacci Extensions in the mid-720′s. Specifically, they were the 161.8% Fibonacci Extensions of the two most significant DJU declines of the past decade, in 2008-2009 and 2015. Indeed, the rally would peter out at 724.

In the subsequent decline, we began posting about how the DJU was precisely following the technical “road map” laid out by its chart. In an August post, we indicated that the latest signs on this map appeared to be pointing to a test of the former breakout level. Specifically, we said that if “the index holds above 670-ish, the road should lead higher. Although, a detour toward the low-650′s level that marked the breakout of the January 2015 highs would not be a shock.” The index would bottom out at 656 in the early-September selloff.

In the mid-August post, we noted that “on the upside, the index may run into a roadblock in the low-700′s”. A week ago, the DJU reached nearly 699 before being turned back forcefully. As of this morning, the index had dropped 6% and was back down testing the ultra-important 655 area again. In our view, it best be bouncing here.

As the chart indicates, not only does this 655 area signify the breakout level, it is also represented (not surprisingly) by several other key levels. These include:

The 23.6% Fibonacci Retracement of 2012-2016 Rally

The 38.2% Fibonacci Retracement of 2015-2016 Rally

The 200-Day Simple Moving Average

This is pretty substantial support for the DJU in the 650′s. If it can hold, this 2nd “re-test” of the breakout area could offer a green light for a more durable up-leg in utilities. On the other hand, should the area fail to hold, all this action of the past 6 months may prove to be nothing more than a false breakout. In that case, the road signs may as well say “Bridge Out”.

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Utility stocks have been unusually responsive to key chart levels recently.

As money managers who rely quite a bit on the charts, it’s always comforting to work with securities and data series that conform reliably to charting analysis. On the other hand, most chartists can probably think of a handful of tickers that never quite seem to do what they’re “supposed to”. One of my charting nemeses has always been the utility sector, specifically, the Dow Jones Utility Average. For whatever reason, the index has always seemed to zig when I thought it would zag, and vice versa. However, the tables have turned in 2016 as utilities have closely followed the “map” as far as conforming to standard charting practices. Thus, the sector has been pretty good to us this year -- and many others, no doubt (though admittedly that fact has me a bit nervous).

One example of the sector’s conformity dealt with its breakout, and subsequent tests, that we noted back in early April. The near textbook breakout launched the utilities on a tear that would cement the sector as the star of the first half of the year. It would be a very different story as the second half began, however, as the utility sector immediately topped out. Again, though, the charts gave us an accurate head’s up of a potential stalling out by the sector.

We’ve written many times about Fibonacci analysis in these pages. Once again, it is a mathematical sequence of numbers that appears in all walks of nature and elsewhere, including the markets. On July 5, we posted a chart on Twitter and StockTwits (follow us on both: @JLyonsFundMgmt) showing how the Dow Jones Utility Average was in the vicinity of 2 noteworthy Fibonacci Extensions. These Extensions refer to a magnitude of gain that will often contain prices, based on the size of a correction or trading range from which they have emerged.

For example, the 2 most noteworthy corrections in the Dow Utilities over the past 10 years occurred from 2008-2009 and from January-September 2015. If one calculates 61.8% (i.e., the result of dividing one Fibonacci number by the next in the sequence) of the height of each correction range and adds it to the top of the range, the result is the 161.8% Fibonacci Extension of the range. As it turns out, the 161.8% Extension of the 2008-2009 decline is at approximately 720. Similarly, the 161.8% Extension of the 2015 decline lies at approximately 730.

Thus, when the Dow Utility Average was approaching, or hitting, that vicinity, it was suggested that the rally may at least soon pause for a breather. And indeed, the index would peak on July 6 at 724.

Here’s a closer look at the action of the past year and a half.

You may notice at the far right of the chart that prices finally did bounce over the past 2 days. The bounce also occurred according to the charting road map. Specifically, the index dropped back to the level from which it broke out (~670) back in early June. And on cue, utility stocks bounced some 3.5% off of Wednesday’s test of the breakout level.

So where does the map go from here...and will utilities continue to follow it? Well, a chart can certainly serve as a fine map, but it is not a crystal ball. As far as adhering to the map, we will continue to play the Dow Utility Average as if it will be respectful of the charting signs along the way, as it has recently.

That means that, as long as the index holds above 670-ish, the road should lead higher. Although, a detour toward the low-650′s level that marked the breakout of the January 2015 highs would not be a shock. On the upside, the index may run into roadblocks in the low-700′s and at the highs around 724. And if the index is going to break out of this recent range, in either direction, it will likely take, as the sign in the photo says, some serious work ahead by the utilities.

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After breaking out to an all-time high last month, the Dow Jones Utility Average rebounded successfully off its first test of the breakout level.

Just a quick post today. We’ve noted several times over the past few months that even during this strong post-February bounce off of extreme oversold levels, the defensive sectors have continued to lead the way higher. This includes the utility sector which provides the material for our Chart Of The Day. After breaking out to an all-time high last month, the Dow Jones Utility Average saw its first test of the breakout level this week. And based on preliminary readings, it is passing the test.

So if you’re wondering whether you should jump aboard the recent biotech bounce or not, just remember that there are actually areas of the market that are still making higher lows and higher highs -- and all-time highs at that.

Have a great weekend.

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While the broad stock market has been getting hammered, the utility sector hit a 52-week high this week -- and achieved a significant relative breakout.

Our firm’s philosophy when it comes to investment selection, i.e., where to invest, is to concentrate in the strongest performing areas of the market. We refer to this as relative strength. Typically, this means the sectors that are rising more than the rest, especially on a risk-adjusted basis. Occasionally, though -- in a market correction or bear market -- it can mean the sectors that just aren’t losing ground, or are losing the least. This is the case currently with the utility sector. For, while most areas of the market are off to a historically weak start, utilities are up 8% for 2016, as measured by the Dow Jones Utility Average (DJU). Furthermore, while the DJU is up a mere 1.7% over the past 52 weeks, it is nevertheless at a 52-week high.

Additionally, as the chart indicates, the utility sector has broken out of a well defined downtrend on a relative basis versus the S&P 500. While there is no guarantee, this does suggest that, over the longer-term, the utility sector could be in the early staged of out-performance versus the market. And based on past occurrences when we have witnessed relative breakouts of some variation (e.g., 2000, 2007), this is not necessarily a positive development for stocks overall.

It remains to be seen whether similarly challenging times will materialize for the broader market versus utilities over the longer-term, but that trend certainly is in effect at the moment.

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“diffuse station” photo by Hope Abrams.

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This is a quick and simple post on the Dow Jones Utility Average (DJU), which is testing a clearly defined UP trendline from its lows in 2009. We say clearly defined as it has been precisely touched by lows in 2011 and 2014 (and almost in 2012). Thus, it meets our criteria for a valid and relevant trendline as it has had at least 3 prior touches. The Utility Average has spent much of the past 8 days treading this trendline, around 544.

Now, we never want to anticipate a breakdown. Therefore, we will assume the trendline holds as support until it doesn’t. However, there are a few things that make us skeptical that the trendline isn’t going to be broken relatively soon. For one, the DJU has already broken down below significant Fibonacci support in the vicinity of 575. And after an ill-fated attempt to regain the level in August, it is back down below there.

Secondly, the DJU has had difficulty thus far mounting any kind of a bounce off of the line. In previous touches, the index had bounced almost immediately. The longer the index rests on the trendline, the more likely it is to break, eventually.

Lastly, the index certainly has had company in terms of indices or securities breaking major trendlines lately. After a 2-year straight-up rally, we have witnessed a plethora of significant trendlines being broken lately. So while it would have been perhaps surprising to see such a trendline broken in 2013 or 2014, it would be much less of a surprise now.

Should the trendline indeed break, the next significant level of potential support, in our view, comes near the 520 level. This area represents a breakout level of sorts above the 2007-2008 peak as well as the 2013 highs. That level also lines up with the next cluster of Fibonacci Retracement support from the key lows in 2009 and 2012. Should the trendline break, that 520 level could come pretty quickly.

So that’s it -- short and sweet. As long as the Dow Jones Utility Average remains above its post-2009 UP trendline, its prospects are bullish. Should the trendline fail, it opens up the 520 level for testing...and quickly.

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Utility Sector Testing Key Near-Term Support Level

With a gain of roughly 26% last year, the utilities were one of the best-performing sectors in 2014. With bond yields dumping, investors ran to anything with a competing yield and utilities have traditionally fit that bill. That strong run ended abruptly, however, at the end of January. As bond yields have jumped since then, Utilities have slumped, losing about 13% in the past 6 weeks. This decline has taken the Dow Jones Utility Average (DJU) down to its first key support level around 570, in our view. This area marks a confluence of important studies, including:

61.8% Fibonacci Retracement of August-January Rally ~575

38.2% Fibonacci Retracement of 2012-2015 Rally ~572

23.6% Fibonacci Retracement of 2009-2015 Rally ~570

Post-January 2014 UP Trendline ~570

October 2014 Breakout Level ~570

Should the DJU hold this area, the first major test of resistance on the upside may come in the 600-608 range which would mark the 38.2% Fibonacci Retracement of the current post-January decline, the 50-day simple moving average and the tops in November, early December and late February. If it can surpass that level, perhaps new highs are in store for the DJU. If not, the real possibility exists that the January highs will mark the top for some time.

We’re getting a little ahead of ourselves, however. The first test is here near 570. If it fails, the next key level below is near 520, in our view. The studies there mirror those at the 570 area:

61.8% Fibonacci Retracement of 2012-2015 Rally ~520

38.2% Fibonacci Retracement of 2009-2015 Rally ~516

Post-2009 UP Trendline ~520

March 2014 Breakout Level ~520

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From the Stock Trader’s Almanac 2015, page 92, Sector Seasonality, there are two sectors that begin their seasonally favorable periods in March: High-Tech and Utilities. High-Tech sector exposure already exists in the Almanac Investor ETF Portfolio. Last year, the Utilities sector started off the year on a near chart-perfect bullish climb from the bottom left to the top right. This trend was briefly interrupted with a period of sideways trading that ran from early May through the beginning of October. Since breaking out to new highs in late-October, the sector has soared. It was one of the top-performing sectors of 2014. 

One of the key themes of 2014 was this notion that the U.S. was decoupling from the world. The narrative - Japan may be in recession, Europe in a deflationary collapse, and China slowing - but the U.S. is strong and is an island unto itself.

The narrative, though, is not the same as reality. While the U.S. economy has certainly fared better than its global peers, an “acceleration” we have yet to see, with real GDP still showing the slowest post-war recovery in history and real wage growth telling the same story.

What, then, are investors basing their decoupling theme on? Very simply, the U.S. stock market, which to put it mildly has been trouncing its global peers since 2010. Five years of outperformance is a long time and enough to build a strong case for just about anything.

If we look away from just the large cap stock indices, though, the U.S. story looks more like Europe and Japan than most investors may want to believe.

Falling Inflation Expectations

First, inflation expectations in the U.S. have been falling precipitously over the past year with breakeven rates (2-years through 30-years) back to their lowest levels since 2009.

Yield Curve Flattening

Second, the yield curve in the U.S. is flattening, down to a 129 bps spread between the 10-year yield and the 2-year yield.

Yields Plummeting

Third, like Europe and Japan, U.S. long duration yields have plummeted over the past year. The 30-year Treasury yield is at a new all-time low, below the crisis lows of 2008.

Credit Spreads Widening

Fourth, credit spreads in the U.S. are widening, with the high yield index showing a 542 basis point spread, up from 388 basis point one year ago and 335 basis points last June.

Defensive Sectors Leading

Fifth, within the U.S. stock market it is not cyclical but defensive sectors (Utilities, Health Care, and Consumer Staples) that have been outpacing the S&P 500 since the beginning of 2014.

Leading Indicators Turning Down

Sixth, if we look past lagging indicators like GDP and focus instead on leading indicators, they are telling a different story.

The growth rate on the ECRI Weekly Leading Index has moved into negative territory, at its lowest level in three years.

Similarly, the U.S. composite PMI Output index is showing its slowest rate of expansion in 14 months.

Unprecedented Fed Action (0% Policy)

Lastly, the U.S. Federal Reserve continues to behave as if we are very much like Europe and Japan, holding interest rates at 0% now for over six years.

Entering the year, many were predicting a rate hike by mid-2015, but the expectations for a Fed rate hike continue to be pushed out  as the stock market ticks lower. The futures market is now anticipating the first rate hike will not occur until October 2015 and we are not far from shifting to December 2015.

The Decoupling Myth

Collectively, these factors suggest that the U.S. is not immune to a global slowdown. Indeed, it is already starting to feel the effects if we look at anything except the S&P 500. From easy monetary policy to plummeting yields and inflation expectations, the U.S. looks very much like its global peers. Moreover, the widening of credit spreads and outperformance of defensive sectors suggest that market participants are already starting to appreciate this and position accordingly.

What we have yet to see is large cap U.S. stock indices reflect this risk but as I wrote recently, that too may be changing here. Narrative follows price. If the v-bottom pattern that has persisted in the U.S. since the beginning of 2013 ends in the coming weeks, expect confidence in the narrative of "U.S. decoupling" to end with it.

At Pension Partners, our Beta Rotation and Inflation Rotation strategies remain defensively positioned.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.