Despite "Valuation Hawks", Utilities Continue To Be The Market Leader

Valuations are important for long-term performance. The valuation, however, especially when using a 1-year forward PE ratio, has virtually no impact on the medium term as the data clearly shows. Utilities have been "expensive" for months yet the sector has returned over 30% in 19 months, far from a "short-term" trade.

Utilities (XLU) continue to surge ahead, rising over 30% over the past 19 months since the turn in direction of global growth. Despite the massive profits that could have been made in the utility sector over the past year, consensus opinion and more specifically, "valuation hawks", regard this sector as a bad investment, steering investors into less profitable investments.

Valuations are important for long-term performance. The valuation, however, especially when using a 1-year forward PE ratio, has virtually no impact on the medium term as the data clearly shows. Utilities have been "expensive" for months yet the sector has returned over 30% in 19 months, far from a "short-term" trade.

(Click on image to enlarge)

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Bloomberg

Staying away from this sector, at a time when global economic data supported an overweight position, likely caused underperformance and was clearly a massively missed opportunity to make several years of gains in one defensive sector.

For those that either subscribe to EPB Macro Research or have been following my work for a number of years know that I have been highly bullish of utilities for a long time, initiating a long position back in May 2018 (alongside a short position in regional banks). This position was initiated on the basis of slowing growth expectations and faltering inflation expectations, two conditions that drive nearly all asset classes and easily trump "valuation" over 12-36 month time horizons. The most important factor for your portfolio and your investment choices is the trending direction of the economic cycle.

In a recent note on why cycles matter, which you can read by clicking here, I highlighted seven "up cycles" and seven "down cycles," the seventh which we are currently still in as outlined by the data below.

The cycles, defined using the IHS Markit Global PMI and several factors such as the length of the decline, the magnitude of the decline and the breadth of the decline are outlined in the chart below. Down cycles are from points A to B and up cycles are from points B to A.

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