Even if you’re not invested in bonds, there’s a good chance that your portfolio has been deeply affected by the sharp rise in Treasury yields that has occurred this summer. The 10-year closed at 2.88% on Monday, up from 1.63% on May 2. While this move has led to sharp downturns across the bond market, the disruptions in the stock market also have been enormous in terms of what sectors have lagged and which groups have outperformed.
To update an old Wall Street saw, “Don’t confuse brains with a (bond) bear market.”
First, a look at the victims of rising Treasury yields is notable for its size and breadth. The table below shows the impact that rising rates have had on the so-called “bond substitutes” and the performance of housing-related shares:
|ETF||TICKER||RETURN SINCE 5/2|
|iShares U.S. Real Estate ETF||IYR||-14.8%|
|iShares U.S. Home Construction ETF||ITB||-13.1%|
|iShares U.S. Preferred Stock ETF||PFF||-6.9%|
|Consumer Staples SPDR||XLP||-1.2%|
|Alerian MLP ETF||AMLP||+1.9%|
|iShares Select Dividend ETF||DVY||+1.9%|
|SPDR S&P 500 ETF||SPY||+4.4%|
The rise in Treasury yields has not only pressured these rate-sensitive groups; it has also contributed to the outperformance for higher-risk and more economically sensitive sectors. While it’s counterintuitive that a more challenging market environment would help higher-beta market segments, that is in fact exactly what has occurred. Consider the following results from the May 2 nadir in Treasury yields through Friday, Aug. 16:
- The PowerShares S&P 500 High Beta Portfolio (SPHB) (+10%) has trounced the return of PowerShares S&P 500 Low Volatility Portfolio (SPLV) (-1.9%), which has suffered from its massive weightings in the utilities and consumer staples sectors.
- Non-dividend-paying stocks have comfortably outperformed their dividend-paying counterparts.
- Small caps have outperformed large caps, with the iShares Russell 2000 ETF (IWM) gaining 9.5% and topping the 4.4% return of the SPDR S&P 500 ETF (SPY) by a wide margin.
Perhaps most notably, the sectors furthest from the yield/safety trade have held up very well. Since May 2, the two Select Sector SPDRs most sensitive to global growth — the Materials SPDR (XLB) (+5%) and the Industrial SPDR (XLI) (+9.2%) — have outperformed the broader market by varying degrees.
There’s no doubt that much of the strong showing for these two sectors has to do with improving sentiment regarding China’s economy and the growth outlook for Europe. At the same time, however, investors are demonstrating a clear preference for market segments that provide the greatest distance from the downturn in bonds. In fact, since Aug. 1 — a time that has seen heavy outflows for broad-based equity funds — the Industrial, Technology (XLK) and Materials SPDRs have attracted a combined $515 million in net inflows.
Why does any of this matter? Very simply, investors need to be very careful in drawing firm conclusions from recent performance results. Not only have the losses in certain market segments reached extreme levels – REITs and preferred stocks stand out on this front – but the move in cyclical areas may have grown somewhat long in the tooth.
The materials sector offers a prime example. Even though the group has outperformed of late, earnings estimates for both this year and next are plunging almost across the board, with steel and mining companies hit particularly hard. To cite one extreme example, Freeport McMoRan Copper & Gold (FCX) has gained nearly 19% since late June, yet at the same time, its 2013 EPS consensus estimate has plunged from $3.65 to $2.41 in the past 90 days, while its 2014 estimate dropped from $4.21 to $3.14. This sort of downward earnings momentum clearly isn’t the basis for sustained outperformance.
The Bottom Line
Just as quantitative easing distorted financial-market performance on the way up, so too is the threat of its removal affecting performance on the way down. With two key events related to QE rapidly approaching — the Sept. 6 jobs report and Sept. 17-18 Fed meeting — investors need to be keenly aware of how much their holdings’ performance is being driven by interest-rate risk rather than fundamentals.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.