Consider Taking Profits on Utility Stocks

NEW YORK ( TheStreet) -- Investors seeking dividend yields have been riding the bull market for stocks in the Dow Jones Utility Average.

One way to invest in these utilities is through the Utilities Select Sector SPDR ( XLU), an exchange-traded fund that tracks 31 utility stocks.

XLU has a dividend yield of 3.6%, a significantly higher return than the current 1.55% yield on the 10-year Treasury.

The question for investors today is whether to chase the upward market momentum in the Utilities SPDR when several components in the exchange-traded fund reached all-time highs on Friday.

I favor booking profits on market strength in anticipation of further quantitative easing by the Federal Reserve.

Now let's look at the weekly chart of XLU below.

Momentum is extremely overbought with a (12x3x3 weekly slow stochastic) reading of 88.23 on a scale of zero to 100.00, where a reading of more than 80.00 is overbought.

XLU ended the week well above its five-week modified moving average at $37.03. As long as weekly closes are above the rising five-week modified moving average, the weekly chart profile will remain positive but overbought.

My "buy and trade" investment strategy recommendation for XLU is to use good-'til-cancelled limit orders to sell strength to my weekly and quarterly risky levels at $38.74 and $39.89, respectively.

What I am concerned about is a potential technical sell signal where XLU has a weekly close below its five-week modified moving average with the momentum declining below 80.00. The downside risk on this sell signal is to the 200-week simple moving average at $31.19.

Source: Thomson Reuters

The pop-up table below shows data from www.ValuEngine.com covering the 31 components listed according to index weighting.

I did not include the data for Duke Energy ( DUK) as the metrics have not been updated since the company's merger with Progress Energy, which closed on July 2.

Reading the Table

OV / UN Valued: The stocks with a red number are undervalued by this percentage. Those with a black number are overvalued by that percentage, according to ValuEngine.

VE Rating: A 1-Engine rating is a strong sell; a 2-Engine rating is a sell; a 3-Engine rating is a hold, a 4-Engine rating is a buy; and a 5-Engine rating is a strong buy.

Last 12-Month Return (%): Stocks with a red number declined by that percentage over the last 12 months. Stocks with a black number increased by that percentage.

Forecast One-Year Return: Stocks with a red number are projected to decline by that percentage over the next 12 months. Stocks with a black number in the table are projected to move higher by that percentage over the next 12 months.

Analysis of the Utilities Sector

It is unusual that the utilities sector becomes the most overvalued sector according to ValuEngine, but it has done just that. The utilities sector is 12.9% overvalued, which is a solid reason to book profits on the Utilities Select Sector SPDR.

The pop-up table above shows that only seven of the 31 stocks in the XLU are undervalued, with PPL Corp. ( PPL) undervalued by 20.0% and AES Corp. ( AES) undervalued by 14.9%. Both have buy ratings according to ValuEngine, with reasonable price-to-earnings ratios of 11.4% and 12.0%, respectively.

Looking at the performance measures, 23 of the 31 stocks in the XLU are up by double-digit percentages over the past 12 months, led by NextEra Energy ( NEE), which is up 30.5%; Sempra Energy ( SRE), which is up 43.1%; Wisconsin Energy ( WEC), which is up 35.3%; CMS Energy ( CMS), which is up 32.0%; and Pinnacle West Capital ( PNW), which is up 31.5%.

NextEra reached a multiyear high on Friday. Its all-time high is $73.75 and was set back in January 2008.

Sempra Energy set an all-time high at $71.10 on Friday. Wisconsin Energy reached its all-time high at $41.30 on July 20. CMS Energy set an all-time high of $24.90 on Friday. Pinnacle West also set a new all-time high on Friday at $54.66.

Each of these stocks have a buy rating according to ValuEngine, but buying these now is betting on a continuation of momentum. This is a risky investment strategy as stodgy utility stocks are typically not momentum stocks.

To summarize the downside risk, if the XLU declined to its 200-week simple moving average at $31.19, the loss would be 18.1%, which would wipe out five years of dividend payments.

At the time of publication, Suttmeier held no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading Treasury securities in the primary dealer community. In 1981 he formed the government bond department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. Capital Markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy. You can reach Richard at RSuttmeier@gmail.com

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