Utilities Power Down

08/05/05 03:17:43 PM

by David Penn

Rising long-term interest rates add to the pressure on utilities stocks.

Security: UTH
Position: N/A

One of the best lines I've heard in recent days about the housing bubble debate came from an article in BBC News this morning. Richard Donnell, spokesman for real estate agent FPDSavills in Halifax, was quoted in a piece called "How to beat a falling housing market" as saying, "There are still plenty of buyers; they are just demanding quality and value for money."

And of course, it is a "demand for quality and value for money" that's been driving house prices higher, right? Certainly not in Las Vegas. As Ky Plaskon reported for National Public Radio back in June, the building boom in Las Vegas has been "plagued by construction defects." Special courts set up to handle these disputes between builders and new homeowners have been completely overrun by the number of cases being brought before them in recent months.

But I digress. It is axiomatic that borrowing rates rise; those industries that rely a great deal on borrowing tend to underperform those that do not. This includes a number of industries, but perhaps none so centrally as the utilities industry. Why? Because, as Gary Kaltbaum, money manager and host of Investor's Edge, pointed out to his radio listeners recently, the scale of borrowing that utilities must do on a regular basis makes them particularly vulnerable to increases in interest rates.

As such, it is little wonder that utilities stocks have been among the best performers during a cyclical bull market characterized by abnormally low borrowing costs.

Figure 1: A shooting star, a negative stochastic divergence, a 2B top, and a MACD histogram slipping back into the negative are four of the technical "horsemen" stalking the rally in the utilities HOLDRS.

Graphic provided by: Prophet Financial, Inc.

Even taken on its own merits--apart from whatever interest rate-induced trauma they may have suffered--the utilities stocks have started to look "toppy" in August. The dominant technical feature is a Japanese candlestick--a relatively wide-bodied shooting star--that has appeared in early August and towered over the preceding price action. This sort of candlestick is most often connected with corrections in the major trend--corrections that may or may not grow into full-fledged reversals.

In addition, the shooting star candlestick arrives as part of a negative stochastic divergence. Compare the higher highs in price between July and August with the lower highs in the stochastic over the same time frame. A clear negative stochastic divergence emerges that suggests that the market's advance has come as far as it will for the time being. The negative stochastic divergence also occurs simultaneously with a 2B top insofar as the higher high in August was followed not by further movement to the upside, but with a reversal that took the UTH below the July lows.

There have been other signs of weariness during the utilities rally. Would-be reversal days on July 6 and 14, as well as on June 15, when utilities stocks--as grouped by the utilities HOLDRS or UTH--opened up and closed down big after a few days of rallying higher. This means that speculators should be wary of making too much out of the current weakness in the UTH. By both the divergence confirmation method I've written about before in Working Money as well as the entry rules for 2B tops--to say nothing of the gap down on Friday, August 5--the utilities stocks are officially in trouble. But because taking advantage of such a situation would entail going against what has been up until now a powerful trend, speculators should be wary that a trend of such force might--even temporarily--be able to reassert itself.

A few vulnerable utilities stocks that might be especially worth looking at include eight that were trading below their 50-day exponential moving averages (EMAs) as of Friday, August 5: DTE, DUK, EAS, KSE, NI, PGN, and SCG.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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