The following question was brought up recently: What could the extreme outperformance from utilities mean for both utilities and the S&P 500 for the rest of the year? Looking at 2016, the Dow Jones Utility Average was up 13.3% for the first four months of the year, versus a 1.0% gain for the S&P 500 Index. The consensus thinking is that seeing defensive areas like utilities outperform at such a wide margin could suggest upcoming weakness overall for equities. Historically, in healthy bull markets you want to see leadership come from areas such as technology and small caps, not a defensive sector like utilities.
Going back to 1970, the Dow Jones Utility Average gained more than 8% during the first four months of the year six other times. The rest of the year actually saw an average return of 6.7% for utilities, higher than the average rest of the year of 4.6%. In other words, strength equals strength.
Turning to the S&P 500 Index, the last time utilities were up this much to start a year was 2013. The S&P 500 gained nearly 16% for the rest of that year, so clearly this potential warning sign didn’t work that time. Looking at all the data, the S&P 500 returned slightly more than the average rest of the year, at 4.8% versus 4.3%.
What is also worth noting is the S&P 500’s standard deviation for the rest of the year after utilities are strong is lower than average. So returns are better for the S&P 500 and there is less volatility—that probably isn’t what most people expect when utilities are strong to kick off the year. Now, be aware that the 12-month returns on the S&P 500 after strong utility performance are rather weak, up only 4.0% on average—nearly half the average 12-month gain since 1970. This leads to the question, does this warning sign just take longer to play out?
Strength in utilities to start a year does not seem to be the major warning sign for equities as some have suggested. At the same time, there have only been six occurrences of strong utilities to start the year going back to 1970; thus, the sample size is very small and this can distort things. We continue to expect mid-single-digit gains for equities in 2016,* and that volatility will remain high as well; this study does little to change our views.