Market Insights

Massive rotation underway as optimism spreads

By David Russell

Some people may confuse energy and utility stocks, but they’re not likely to make that mistake right now.

Energy’s up 4.5% in the last week, compared with a 4.8% drop for utilities over the same time frame. The resulting 9.3 percentage-point difference is the widest performance gap between the two in almost a decade, according to TradeStation’s data systems.

What’s driving the bipolar performance? Traders point to a few things. First, crude oil refuses to back down after adding a third of its value since the summer. Futures are bucking a resistance line around $58 where they failed in mid- and late-2016. Speculators increasingly think the third time will be a charm.1 After all, they say, economic enthusiasm is mounting,  while OPEC’s determined to keep a lid on supply.2 (Don’t forget Saudi Arabia wants to IPO its state oil company in 2018.)

Things aren’t so wonderful for utilities. They typically move in the opposite direction as interest rates, so are hurt by accelerating GDP and higher bond yields. Even worse, they’ve gotten burned by wildfires in California.

Given their different businesses, energy stocks and utilities usually have little to do with each other. But the sharp divergence between the two highlights a growing consensus about next year: Investors see stronger growth lifting cyclical companies like energy, financials, industrials, and materials. But that will reduce the appeal of income stocks (throw real-estate investment trusts in that bucket, too). The big question will be Technology. Sure it benefits from a good economy, but will portfolio managers tolerate the sector’s higher P/E ratios if rates shoot higher?

1. Bloomberg: Hedge Funds Eye Oil’s Year-End ‘High Note’ After Bumpy 2017. 12/15/17.

2. RTT News: Bundesbank Raises Germany’s Growth Outlook. 12/15/17. Fed lifts interest rates but sticks to go-slow approach as Yellen era nears end. 12/13/17.
Reuters: Japan upgrades GDP growth forecast, CPI seen far below BOJ target. 12/18/17.

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