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CHAPEL HILL, N.C. (MarketWatch) — A bullish signal in U.S. stocks is being issued by an indicator that few investors ever focus on: the Dow Jones Utility Average.
That’s because this benchmark (DJU) which was created 88 years ago, in 1929, is thought to be a leading indicator of tops and bottoms in the broad equity market. And, by virtue of hitting an all-time high last week, it is suggesting that the market still has further to rise.
How much further? Kelley Wright, editor of the Investment Quality Trends newsletter, says the “the DJU [historically] has tended to bottom and top three to six months before the Dow Industrials.” If the future is like the past, therefore, the DJU’s new high means that the earliest the broad market would top out is the last quarter of this year.
Wright’s newsletter has one of the best long-term records monitored by my Hulbert Financial Digest performance-monitoring service. I calculate that it has beaten the broad market by 1.5 annualized percentage points over the past 30 years, while nevertheless incurring 12% less risk (as measured by volatility of performance). That’s a winning combination, and his service is in first place for risk-adjusted performance over this three-decade period.
However, we shouldn’t throw caution to the wind, according to Wright. That’s because the Dow Utility’s dividend yield of only 3.2% is barely higher than the 3% yield that historically has accompanied tops. In fact, Wright said in an interview, he considers the DJU’s current yield to be statistically within the “same zipcode” as the “overvalued” zone.
To square those two perspectives, it’s important to realize that Wright’s dividend-based valuation model is not a short-term market-timing tool. It can take a number of years for overvaluation to give way to undervaluation. One year ago, for example, the Dow Jones Utility Average was yielding 3.3%, and here we are a year later with the broad market, as measured by the S&P 500 Index (SPX) 15.5% higher.
But one thing the market did have going for it a year ago, as I pointed out at the time, was a new high for the Dow Jones Utility Index. Like then, that’s what the market has going for it now too.
So the picture the Dow Jones Utility Average is painting is of near-term strength and long-term weakness. Let’s hope the stock market over the next 12 months does even half as well as it has over the past year.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email email@example.com.