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Declining Utility Stocks Signal Gains Ahead for Russell 2000

NEW YORK (TheStreet) -- As funds begin to flow from large-cap names such as Utilities Select Sector SPDR (XLU) into smaller-cap indexes such as iShares Russell 2000 Index (IWM), U.S. equities may be poised to push towards new record highs.

The utility sector index is most heavily weighted by Duke Energy Corporation (DUK - Get Report), NextEra Energy Inc (NEE - Get Report), Dominion Resources Inc (D), Southern Co (SO) and Exelon Corp (EXC).

Utility stocks have broken key support areas in recent weeks, signaling that further selling pressure could take shape. In contrast, the Russell 2000 index is experiencing buying pressure off of long-term support levels, indicating possible strength ahead.

The relationship between the Russell 2000 index and utility stocks is significant as it represents investors' appetite for risk. From March till early May, the small cap index declined nearly 10%. Investors feared that both high-beta internet stocks and biotech companies were entering bubble territory after large gains the previous year. During that time, utility stocks outperformed the broader SPDR S&P 500 Index (SPY) as investors bought up low-beta assets to avoid volatility in U.S. equities.

XLU Chart
XLU data by YCharts

The recent shift from utility stocks to small-cap stocks has come amid a few key macro-fundamental developments. The U.S. economy last week proved healthier than was previously believed. Economic activity and the labor market did not only show positive data in the second quarter, but first quarter numbers were revised higher.

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Similarly, geopolitical risks in Gaza and Ukraine look to be lessening after spiking last week on a flurry of headlines. Declines in both United States Oil (USO) and safe-haven SPDR Gold Shares (GLD) show that investors are not currently as concerned as they once were with overseas events. 

Funds flowing into higher-beta U.S. assets sends a very loud message that investors are still willing to buy stocks on dips. An improving economy, diminishing geopolitical risks, and funds flowing into small cap indexes indicate that the rally in U.S. equities may not be finished just yet.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @macroinsights

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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