INVESTING: Utilities finally stumble, but don’t lose faith in them

A go-to trade for the last few years is losing some of its sheen. This market-leading sector offered one of the true gems of investing: market-beating returns without a lot of extra risk. A change in that might send small ripples throughout your portfolio.

The utility sector has been one of the few areas that led from the lows in early 2003 right up until a few weeks ago. While home builders dropped out more than a year ago and technology has come and gone, power producers along with materials and energy have shown consistent performance for more than four years.

Even occasional readers of this column will remember that almost every other week since late September has ended with this comment: “It remains a buy-the-dip environment, concentrating on utilities, energy, industrial and materials.”

However, interest rates started going up a month ago, and that’s when utilities started trailing. That’s a reversion to the historical relationship between the two. But in 2005 and 2006, utilities found a way to keep moving higher despite rising rates. That’s one of the reasons for throwing up a caution flag today.

Sometimes, making trading decisions is easy. Price goes to a new high, but internal indicators don’t follow. That’s a good time to sell. Price drops on low volume can be a buy.

But neither of these conditions applied to the recent lag in utilities. Most of the major stock market indexes hit their rally highs June 1. The utilities last hit a high May 21, leaving a seven-day lag period. That might not sound like much, but utilities have rarely lagged since 2003.

Catching the divergence early gave us solid outperformance over the last month, with the utilities down more than 7 percent and the industrials, energy and materials down just 2 percent to 3 percent. Again, that doesn’t sound like much, but put that over a full year, or more important, for the life of your portfolio, and it’s a significant number.

Given that the divergence since utilities last hit a high has been small, you might want to do nothing more than trim your investment in the sector a little and reallocate to one of the higher-rated ones. Odds are that the run for utilities isn’t over, and they could set a new high over the intermediate term. But at this late stage of the bull market, it becomes a question of trying to squeeze the last dime out of the overall run, and I’m more comfortable trying to do that with sectors that are still attracting investor interest.

There is another reason a little caution may go a long way when it comes to utility stocks. Historically, the sector tops out from nine to 12 months before the rest of the market. Again, I don’t believe utilities have topped, and therefore the rest of the market should have a lot more room to advance.

At the same time, this bull market will die at some point, and the utilities could foreshadow that ending. And when minor divergences turn into major ones, it is time to sit up and take notice.

For now, put the utilities in the penalty box, but they don’t deserve full-game suspensions yet. However, if the infractions keep coming, more defensive action might be warranted.