Sector Rotation: Are Utilities Gaining as Financials Weaken?

Key Points

• The Financial Select Sector SPDR ETF (XLF) is up 6.5% YTD, driven by strong earnings and optimism around Trump’s presidency.
• Early signs of selling pressure and overbought conditions could lead to a pullback for financials and rotation back into other sectors.
• The utility sector is up 2.89% YTD, lagging financials but maintaining positive sentiment, with technicals showing a potential breakout near $80.

One of the top-performing sectors YTD has been financials, with the popular financial ETF, Financial Select Sector SPDR NYSEARCA: XLF, already up 6.5% as of Friday’s close. Conversely, one of the sectors that outperformed for the first three quarters of last year, utilities, represented by the Utilities Select Sector SPDR ETF NYSEARCA: XLU, has lagged financials and performed in line with the benchmark S&P 500. 

However, with rotation constantly occurring in the current market and capital flowing out of potentially overbought sectors and into sectors presenting more favorable risk: reward, could utilities gain flow from financials and gain a boost in the coming months?

Financials Outperform Early On But Face Selling Pressure

The XLF, which tracks the financial sector within the S&P 500, has experienced a strong start to 2025, yielding a year-to-date and outperforming return of approximately 6.5% as of Friday’s close. This performance reflects an optimistic outlook influenced by expectations around policy changes, particularly with Donald Trump as the 47th President of the United States. Along with the upbeat outlook, earnings for many of the ETF’s major players and holdings significantly beat expectations, resulting in significant upward momentum for the sector. For example, on January 15, the ETFs second-largest holding, JPMorgan Chase (NYSE: JPM), with a 10.2% weighting, topped EPS by over 17% and sales by 2%, helping the XLF break out of its declining consolidation.

However, this initial surge has been followed by early signs of selling pressure, potentially due to the sector swiftly entering overbought territory. Technical analysis suggests a risk of forming a double-top pattern, indicating that the sector might be due for a pullback or consolidation, which would allow recent gains and price action to digest the move. 

This scenario unfolds against a backdrop where earnings reports have been largely positive and with financial institutions facing a favorable tailwind as they will likely benefit from less stringent regulations thanks to the new White House administration. While YTD net fund flows for the financial ETF are an impressive 4.59%, and momentum is clearly on its side, might the short-term extreme swing to the upside now diminish the risk: reward, setting the stage for another sector to experience fresh flows and renewed optimism? If that were to happen, one sector that could benefit is the utilities sector.

Utilities Consolidate in a Major Bull Flag

For much of last year, the utilities sector ETF, XLU, led and outperformed the market due to several factors. After breaking its downtrend in early 2024, the sector ETF surged from a low near $60 to a record high of $83.41 in late November before returning to its uptrend support line. While the sector has slightly outperformed the benchmark YTD, it’s significantly lagging financials, up only 2.89% YTD. Despite its relative underperformance, the enthusiasm remains, with the fund experiencing 2.45% positive flows YTD. Sentiment remains optimistic for the sector, with holdings in the XLU possessing an aggregate rating of Moderate Buy.

The sector's inherent stability, consistent consumer demand, and defensive characteristics continue to make it a safe haven for investors amidst economic uncertainty. Additionally, the push towards renewable energy, the surge in power consumption from AI and data centers, and recovery from undervaluation in 2023 contributed to its strong performance in 2024 and might continue to do so in 2025. The sector also continues to benefit from the electrification trend, including the rise in electric vehicle usage and increasing electricity demand. Recent comments from President Donald Trump indicate a bullish stance on energy companies. His early actions have made it clear that he aims to rebuild affordable, reliable, and secure energy supplies.

From a technical perspective, XLU remains attractive as it consolidates in a developing bull flag just 6.6% away from its 52-week high and right near a swiftly converging 50- and 20-day Simple Moving Average (SMA). 

While there’s no telling if the sector will attract flows from other leading sectors, such as financials, one thing is for sure: price action. If the XLU can break above its bull-flags downtrend resistance, near $80, that would confirm a technical breakout and potential rotation back into the sector.