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Capital-intensive utility stocks are interest rate sensitive and have an inverse relationship to changes in rates. However, that hasn't been the reality over the past 5-½ years. Faced with continuing recessionary pressures the US Federal Reserve Board on December 12, 2001 cut interest rates for the 11th time, reducing its short-term borrowing rate to low of 1.75 per cent, but by the time the cutting was over in mid 2003, rates were at a 40-year low with the prime rate at 4 per cent and the Fed Funds rate was at 1 per cent. The Fed kept rates low until mid-2004 to ward off potential deflation and to try and re-ignite the U.S. economy.
However, over that same period, as interest rates fell, the Dow Jones Utility Index also declined, contrary to normal trading patterns. The index finally bottomed out in October 2002 and turned positive. It continued to rise even as the Federal Reserve began hiking rates in June 2004. However, from Sept 2005 to the present, the sector, following its own script, paused and the index trended sideways while the Fed continued to raise rates. The end result on a technical basis has been the formation of a saucer bottom from December 2000 to September 2005 and a handle that usually accompanies the pattern forming since then. Also a bullish 3-½ year flag pattern has materialized within the saucer pattern. So where are utility stocks headed now that it appears we are at the end of the rate-hike cycle? In a word, "Higher."
The Dow Jones Utility Index's moving average convergence/divergence oscillator (MACD) has issued a buy signal as it has crossed up above the zero line and above the MACD's downtrend line extending back to September 2005, which could suggest that the handle formation, or consolidation of the bullish saucer pattern may be completing. In addition, the short-term daily moving averages are turning positive and are crossing up one over the other indicating a positive bias.
A close above 421.25 would be a preliminary signal suggesting the sideways consolidation was near an end and a close above 429 would signal a breakout. Once the rally resumes the Utility Index will be on its way to search out the saucer pattern's technical target measurement of about 662 over the next 2-½ years.
A possible investment candidate, which may benefit from the anticipated surge in the utility index would be ATCO Ltd., a Calgary based diversified holding company with operating subsidiaries in electric and natural gas utility operations, independent power operations, production, storage, processing, gathering, delivery of natural gas, technical facilities management for the industrial, defense and transportation sectors, the manufacture, sale and leasing of industrial shelters and industrial noise abatement technologies.
With the share price at $36.60, the company's dividend yield stands at 2.24 per cent and a price-to-earnings ratio (P/E) of 13.10. Comparatively perhaps, not the most attractive dividend yield out there but the company has a record of regular increases in quarterly dividends. Regular dividend hikes suggest not only that a company is well run, but also that its stock has support for steady price appreciation over time.
The company's technical chart reveals a similar pattern to that of the Dow Jones Utility index over the past two years. ATCO's share price accelerated from July 2004, reaching a peak in September 2005 at about $44.00 and since then has been consolidating its gains, but it appears that the consolidation may be nearing an end, just as the Federal Reserve has signaled a pause in rate hikes. The past three sessions has seen the stock appreciate almost 8 per cent, thus a short-term pullback, if it materializes, to the 10-day MA (not shown) at $35.50 would be a better entry price. As the stock rallies it faces overhead resistance at $37-$38, but a close above $38.50 would suggest a breakout of the consolidation. Though there is further overhead resistance in the $38–$42 area, the stock should have sufficient momentum to power through it to its first technical target level of about $45, after which it may consolidate. However, as the stock has traced out a flag pattern since July 2004 the ultimate technical measurement suggest a possible target of about $56.40 over the next 18-months.
Yola Edwards is a contributing writer and technical analyst for Bell Globemedia Interactive, providing options and technical analysis research on a variety of North American equities.