Watts Up? The Reason Behind Q3’s Utility Surge

Talking Equities is a weekly newsletter that provides information regarding equity analysis, investor spotlights, market conditions, and investing strategies. All information provided in Talking Equities should be considered an opinion and not a fact. All information should also be considered as strictly educational. While I would love to claim I have all the answers to cracking the stock market, I simply do not. Invest at your own discretion!

The utilities sector in the third quarter market report

Happy Tuesday Investors,

I’m sorry for the title of this newsletter, but I just couldn’t help myself. I’m nearing my 25th birthday in a couple of months and I can already feel the dad jokes intrusively making their home in my head.

In last week’s newsletter, we discussed how some major global markets have shifted in response to government authorities influencing their economies through interest rate cuts and stimulus bills.

One of the major implications of this within the U.S. is that investors have started to move their money into sectors with more consistent earnings that have proven to perform well in turbulent times. The utilities sector has specifically seen a lot of love, with the third quarter growing around 19.4%.

This week we will be diving into this sector a bit deeper to learn why it is growing so quickly and the outlook of the industry moving forward.

The latest jobs report will have a lot to do with this outlook, as many investors and economic policymakers will use it to make upcoming decisions. We’ll dive into the recently released jobs report and what this means for the U.S. economy.

With all this shifting of money, it’s hard to determine the point at which the utility sector (or any other sector for that matter) will pivot in another direction. Stick around to the end to learn how you can use trading volume as a tool to be prepared for any price changes and new trends that may be occurring.

Let’s get into it.

Index metrics are weekly values and based on 10/04/2024 data.
Economic metrics vary depending on release schedule.
For metric definitions reference this newsletter.

The major market indices clocked in another positive week marking the second consecutive week of gains since the Fed cut interest rates on September 18th. While last week’s gains were significant, this week’s were only slight. This was largely due to the new jobs report which provided insight on the current employment metrics in the U.S.

One of the most significant metrics released on the jobs report was that 254,000 jobs were reportedly added to the economy. This number is well beyond the expected amount of jobs that economists and investors would expect given the current economic conditions. While this does suggest the market seems to be responding well to the interest rate cut, this could also be a sign that inflation is still a very sticky problem.

Not only were jobs added to the economy, but the unemployment rate also went down from 4.2% to 4.1%. Both the addition of new jobs and the decrease in unemployment are indicators that companies in the economy are expanding and experiencing growth. While growth is good, it is also a major reason why the U.S. has been battling inflation over the last four years.

Investors are speculating that the Fed will likely have a more reserved cut in November given the positive performance indicated on the jobs report.

Here's the good news and the bad news.

• The bad news is that markets will still likely be turbulent when the Fed cuts interest rates in November. The combination of the presidential election and the Fed cutting less than they initially did could cause uncertainty in the market.

• The good news is that it looks like the Fed is achieving a soft landing. As of now, they are successfully lowering inflation and interest rates without creating economic disparity.

Sectors that have been performing particularly well in the third quarter will likely continue to do so until there is an obvious change in investor and consumer sentiment. Moving forward, it will be important to follow along with the earnings reports of companies whose operations are affected by interest rate cuts.

Also, the metrics above will be a clear indication of how healthy our economy is over the next couple of months. I believe they are equally as important to consider when picking new investment opportunities.

The utilities sector has seen the largest growth out of any sector in the third quarter. It hasn’t produced nearly as much returns as the tech or financial sector this year, but it has definitely grown the most compared to every other sector this quarter. So what gives?

When we think of utilities, we don’t really think of anything sexy. The first companies that generally come to mind are those that help with operations that involve water, sewage, electricity, and natural gas. In my opinion, it’s not the most interesting sector in the world, but when it starts outperforming everything else, that’s when I start to raise an eyebrow.

After diving in and doing some research, I found out that the growth in the utilities sector has been driven by three major factors…

1. Technological advancement (AI infrastructure, EV adoption, and Nuclear energy)

2. Interest rate cuts

3. A more even distribution of investors in the stock market

Let’s break these down a bit further.

The first point alludes to the technological advancement that has occurred as many companies are competing to evolve and mass-produce new products. It turns out that the electricity demand has skyrocketed in the last year. This has mainly been attributable to the mass amount of electricity needed to sustain the AI infrastructure that many of the Mag 7 companies are developing.

For the past 9-12 months we’ve been watching the AI raze single-handedly support the U.S. stock market. Investors poured billions of dollars into these companies that are developing their AI models and making them available to the public. It turns out that these models require mass quantities of energy due to the vast amount of processing that the data centers must undergo to answer user queries.

As investors have been spending less in tech companies because of the CAPEX (Capital Expenditure) they have poured into AI infrastructure, it makes sense that investors have now flocked to companies that are at the front lines of supporting the energy needed to sustain these models.

We know the demand is there, but now the investors are flocking to the supply.

While this is the most compelling reason for growth, it’s not the only one. EV adoption has also made it’s contribution as the demand for charging stations has increased. Electricity seems to be the main driving force for the utilities sector at the moment, pun intended.

An honorable mention, which isn’t as big of a reason but is still contributing to growth, is consumer sentiment toward nuclear energy. While nuclear energy doesn’t completely fall under the utility section, certain companies qualify under this sector that work within nuclear energy. Positive outlooks on nuclear energy have motivated investors to place their money in companies categorized in the utilities sector.

The second reason the utilities sector is growing is because interest rate cuts have created positive implications for the profit margins of many companies within this sector. With lower interest rates, companies can receive lower financing costs, which in turn leads to increased profitability.

Most companies are experiencing this market wide, so this isn’t too specific to the utilities sector but it is still notable.

The last reason is that investors are starting to evenly distribute across the entire stock market. As the market has become turbulent and uncertain, investors have been moving their money to defensive sectors to minimize risk. The utilities sector has historically been a great place to do this, which is exactly why investors have been flocking to it.

Looking forward, the main question is whether or not the utilities sector continues to grow at the same rate. As of now, signs point to yes. Investors are still placing their money in the sector, signaling a clear trend upwards. Moreover, because the U.S. economy is still in an uncertain state, it remains a defensive sector to minimize risk for your portfolio.

Of course, this assessment could be completely wrong, which is exactly why we will be diving into how to use trading volume as a price confirmation tool in the next section.

I love adding new tools to my investing toolkit. The more tools I have, the more well-equipped I feel to make better investment decisions. In my opinion, you don’t need to know every single technical or fundamental indicator to make a good decision. I have always been taught to have a select few that you deeply understand and use consistently when making trading decisions.

One of the most essential metrics to assess when valuing stocks is trading volume. Trading volume refers to the total number of shares, contracts, or units of a security traded during a specific period. It represents the amount of activity a stock may be experiencing at a current moment.

So why is this important and how can this be used for investment analysis?

Every time trading volume moves up or down with the price movement over a predetermined period of time, there is a good chance you can make an assumption about the stock’s direction.

Take a look at the key below to see how trading volume and price movements tell a story.

⬆️ Trading Volume + ⬆️ Prices = Strong buying interest

Suggests that the price increase is supported by significant participation, making the trend more likely to sustain.

⬆️ Trading Volume + ⬇️ Prices = Strong selling pressure

Suggests that the price decrease is backed by significant selling activity, making the downtrend more likely to continue.

⬇️ Trading Volume + ⬆️ OR ⬇️ Prices = Lack of conviction behind pricing trend

Suggests that the price will move sideways and no obvious trend will reveal itself.

The amount of time that you choose to assess the trading volume will vary depending on the term you are looking to invest. While the actual amount varies, short-term traders typically assess the direction for a couple of days, medium-term traders may assess the direction for 1-3 months, and long-term traders could assess a trend anywhere from 6 months to a year.

Now you have one more tool added to your arsenal of trading knowledge! The more tools that you acquire, the better investment decisions you will be able to make. Keep the information above in mind as you watch the U.S. sectors shift over the next couple of months. Trading volume can be a great tool to use when assessing the overall trend of the market.