With utilities stock valuations creeping higher toward their upper range, the utility sector and related exchange traded fund could begin to dim, according to some technical analysts.
Specifically, looking at the five-year chart, the Utilities Select Sector SPDR (NYSEArca: XLU) is trading at its upper channel. A channel is the area between two parallel trendlines, or a measure of a trading range, with the upper trendline connecting price peaks and the lower line connecting lows.
“The point of trend lines is that I don’t draw them, they draw themselves. This has been a perfect response—perfect!—over and over and over to the top and bottom of the channel,” Sterne Agee’s chief market technician, Carter Worth, said in a CNBC article. And right now, “we are at the top of the channel. And I say, I think you fade it here.”
Since the August 6 low, XLU has surged 14.1%, trading around $45.7, and recently broke above its short-term channel. Consequently, Worth believes that the ETF could pullback to the midpoint of its recent channel formation, or around $42, a 5% decline. [Reliable Utilities Sector ETF Leads in Market Sell-Off]
Additionally, the fundamentals also support potential weakness ahead for the utilities space.
The utilities sector has been one of the best performing areas of the market this year, rising 22.9% year-to-date, benefiting from a low interest rate environment. Dividend-paying utility stocks are a more attractive alternative when bond yields decline. For instance, benchmark 10-year Treasury yields are hovering around 2.35%, compared to the 3.54% 12-month yield from XLU.
However, market observers argue that yields are more likely to fall than rise in the current market environment, which could start to weigh on the utilities sector.
“So you don’t have the tail wind, at this point, for utilities,” Worth added.