The Utility sector signals risk-on

Key points:

• Following a notable spike in outperformance, relative trends for the utility sector suddenly collapsed 
• Similar shifts in relative performance for the defensive-oriented group often foreshadow a risk-on backdrop
• Utilities and other defensive groups underperform the broad market and more aggressive sectors

The Utility sector signals a shift in investors' risk appetite 

During periods of market turbulence, investors frequently gravitate toward the utility sector, strategically positioning their portfolios defensively to cushion potential losses. As market fears subside, they tend to move away from utilities' perceived safety, seeking opportunities in more aggressive groups.

To capture this shift in investors' risk appetite, I calculate the difference between the percentage of S&P 500 Utility sector members outperforming the S&P 500 Index and the percentage of overall S&P 500 members outperforming the Index on a rolling one-month basis. 

During the April drawdown, this spread surged to the 19th-highest level ever recorded, a peak not observed since 1990.

A component in the TCTM Composite Master New Bull Market Model triggered a new alert when the spread cycled from above 48% to below 0%. The previous signal occurred in November 2023, leading to a 20% rally in the S&P 500 over six months.

Similar shifts in utility relative performance preceded positive returns

Whenever the spread between S&P 500 Utility sector stocks outperforming the S&P 500 and all S&P 500 stocks outperforming the benchmark cycled from greater than 48% to less than 0%, the world's most benchmarked index displayed some short-term weakness, likely due to volatility that usually accompanies a transition out of a drawdown period.

Once the near-term sluggishness subsided, the outlook for the S&P 500 was excellent, with performance showing significance relative to random returns from two to twelve months later.

Precedents that were triggered when the S&P 500 traded above its 200-day average, context similar to now, displayed solid returns and consistency, notwithstanding the signals at the outset of the 2022 bear market.

As expected, Utilities and other defensive sectors underperform relative to the S&P 500 and more aggressive groups like Technology and Consumer Discretionary. 

Absolute and relative trend scores

Following risk-on signals from Utilities, the Technology sector was the best-performing sector a year later, which aligns with present-day relative trend scores on both a cap and equal-weighted basis. 

What the research tells us...

Typically, the traditionally defensive utility sector outperforms the S&P 500 during a market correction. A trading model that measures the one-month rolling return spread between S&P 500 Utility stocks and all S&P 500 stocks increased to one of the highest levels in history and subsequently collapsed, triggering a risk-on signal for the broad market. Similar shifts in investors' risk appetite sometimes led to choppy conditions in the first few weeks, a regular occurrence for a market in transition. Investors who took advantage of this backing and filling to boost their market exposure reaped the rewards, as medium and long-term returns for the world's most benchmarked index were outstanding. From a relative perspective, defensive groups underperformed offensive-oriented ones.