Turning point indicators #2 – Financials to utilities ratio

This is our second turning point indicators research notes. In our first research note we looked at the VIX futures term structure and volatility markets can help indicate market bottoms. In this research note we look at the financials to utilities spread ratio. Why is this spread interesting and relevant?

Financials and utilities are interesting against each other because both sectors are the most sensitive to changes and levels in interest rates, but importantly they react opposite to interest rates. Higher interest rates are negative for utilities as their long-term and very predictable cash flows get a lower present value. Financials gain from higher long-term interest rates as it steepens the yield curve and thus help banks expand their net interest margin improving profitability. Because these two sectors are so sensitive to interest rates but with the opposite force the spread ratio provides a very fast signal to investors from policy changes and their impact on interest rates and markets.