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), NextEra Energy Inc (NEE), 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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