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Larry’s note: Welcome to Trading with Larry Benedict, my free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us. My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row. And, I’m featured in the book Market Wizards, alongside investors like Paul Tudor Jones. But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it… |
When it comes to inflation, investors tend to focus on the negatives.
But today, I want to talk about one sector that’s actually seen a positive effect from inflation.
Over the last couple of months, many investors have placed their money into commodities. These include exchange-traded funds (ETFs) with corn and wheat to metals and mining stocks.
For example, we checked out aluminum producer Alcoa Corp (AA) last month. Since the time of writing, Alcoa has risen a whopping 30%.
Now, let’s check out another sector that can be a hedge against inflation due to the way they’re structured: utilities.
To attract the large amount of capital required to fund utility projects, regulators need to ensure that investors earn a sufficient return on their capital over a long timeframe (usually decades).
And a big part of that is dealing with inflation…
Utilities companies are able to adjust for a rise in inflation to avoid generating returns (or losses) below their cost of capital.
However, despite being highly regulated, the Utilities Select SPDR Fund (XLU) can move around quite a bit… which makes for great trading opportunities.
When we last looked at XLU in October 2021 (red arrow), it had just bounced off support (lower orange line)…
Utilities Select SPDR Fund (XLU)
Source: eSignal
That move coincided with the Relative Strength Index (RSI) rallying out of oversold territory (below the lower grey horizontal line).
After a brief pullback where XLU consolidated just above support, XLU rallied up to nearly $68 in October 2021.
When the RSI broke back above resistance in early December (50% – green line), XLU broke out of its sideways pattern and rallied to its then all-time high (A).
As you can see, this is where XLU ran into resistance (upper orange line). It’s also where the share price and RSI diverged, leading to the change in direction.
While XLU made a higher high at ‘B,’ the RSI’s peak at ‘2’ (lower half of the chart) was lower than its high at ‘1,’ where it touched the upper grey horizontal line (overbought signal).
After falling along with the wider market, the RSI has been stuck in the lower band since mid-January.
On the day of the Ukraine invasion, XLU again rallied strongly off support (it has held since June 2021). This happened with the RSI again bouncing off the lower grey line (oversold signal).
Utilities Select SPDR Fund (XLU)
Source: eSignal
After initially stalling at resistance, the RSI recently rose into the top half of its channel (bullish signal). The RSI often stays in this upper band when a stock price rallies.
If XLU continues to rally over the next few days, the 10-day moving average (MA – red line) could soon break back above the long-term 50-day MA (blue line) – which is also a bullish signal.
The next test for XLU will be to re-test its December highs and break above resistance.
Because XLU operates in a highly regulated sector, traders often think that trading opportunities will be scarce.
But while XLU’s long-term trend has been a gradual move higher, it has offered plenty of potential trades in both directions within its long-term range (between the orange lines).
Due to its inflation hedge characteristics, XLU could offer more stability (and predictability) compared to other stocks as volatility continues to rise.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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