Ahead of yet another rate hike from the Federal Reserve (Fed), equity and fixed income markets rose last week. But markets remain choppy and economic fundamentals provide mixed signals. Investors may want to consider the utilities sector to help prepare portfolios for downturns.
This article was written with contributions from Bartlomiej Szczurek. Bartlomiej is a Research Analyst on the SPDR Americas Research Team.
The S&P 500® Index rallied for the second consecutive week despite disappointing earnings results from big technology companies. Treasury yields declined on both the short and long end of the curve amid increasing expectation of a policy pivot from the Fed.1
China’s Economy Grows Even as Equities Decline
China’s economy expanded 3.4% from Q3 last year.2 Yet Chinese equities sold off last week, led by US-listed Chinese stocks, as the government didn’t provide any hint on easing COVID measures during the National Congress of the Chinese Communist Party.
Growth Slows in Europe
Euro-area GDP figures are expected to show that growth slowed sharply in Q3 as soaring energy costs took a toll on consumer demand and industrial activity.
Q3 GDP and Housing Data Released
US GDP grew by 2.6% (forecast 2.4%) in Q3 after two quarters of negative growth.3 While the positive print may have relieved recession fears, accelerating core PCE inflation and resilient consumer spending are unlikely to deter the Fed from its aggressive rate hikes. Rate hikes have translated to soaring borrowing costs for homebuyers; US pending home sales fell by 10.2% in September and 30.4% year-over-year.4
Labor Demand Cools Down
As businesses reassess their labor needs, it’s likely that job openings will continue to fall. The ratio of job vacancies to unemployed persons is likely to decline further.
In Volatile Markets, Seek Downside Defense
Although the US economy avoided another quarter of contraction in Q3, market-based forward-looking indicators are flashing recession warnings as the 10- and 2-year Treasury yield spread has stayed negative for four consecutive months, and the Leading Economic Index (LEI) year-over-year growth fell deeper into negative territory.5
While analysts have been downgrading S&P 500 earnings estimates for both this year and next year amid an economic slowdown and persistently high inflation, utilities have shown a more stable earnings outlook given their defensive business nature and strong capability to pass costs to consumers.6 The utilities sector also carries the lowest beta to the S&P 500 and the lowest downside capture across all GICS sectors. This may help investors navigate a volatile market environment with downside risks.7
Downside Capture and Beta for GICS Sectors
Implementation Idea: The Utilities Select Sector SPDR® Fund (XLU)
According to our sector business cycle analysis, utilities have outperformed the broad market in all previous recession periods by an average of 11%.8 Utilities were also one of the three best-performing sectors during those recessions. Given choppy markets and mixed economic fundamentals, investors may consider allocating to The Utilities Select Sector SPDR Fund (XLU) to help prepare portfolios for an economic downturn. And with over $15 billion of assets and an average trading volume of $1,159 million, XLU has three times the assets and 20 times the trading volume of its next-closest competitor.9
1 Bloomberg Finance, L.P., as of October 28, 2022. 2 Bloomberg Finance, L.P., as of October 24, 2022. 3 Bloomberg Finance, L.P., as of October 27, 2022. 4 Bloomberg Finance, L.P., as of October 28, 2022. 5 Bloomberg Finance, L.P., as of October 28, 2022. 6 FactSet, as of October 28, 2022. 7 Morningstar. Data period: 1/31/1998 – 9/30/2022, except Real Estate (starting from 8/31/2015) and Communication Services (starting from 4/31/2018). GICS Sectors represented by S&P Select Sector Indexes (Total Return). Past performance is not a reliable indicator of future performance. 8 Sector Business Cycle Analysis from State Street Global Advisors SPDR, as of November 30, 2019. 9 Bloomberg Finance, L.P., as of October 28, 2022.
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