Bond yields have surged, and they look poised for more gains. Financial stocks look like the best bets, with manufacturers and energy firms also looking like solid choices.
The 10-year Treasury yield has risen to as high as 1.5% Monday after trading for as low as 1.31% last week. The Federal Reserve is expected to soon taper, or reduce, its bond purchases, which could decrease demand for bonds, lower their prices, and raise their yields. The Fed’s taper—and the slightly higher chance that it raises short-term interest rates in 2022 — isn’t currently expected to to damage economic growth.
That’s all enabling the 10-year yield to rise, reflecting higher expectations for future economic growth demand and inflation. The yield could soon hit 1.7%—or higher. First off, it stood at 1.7% in May, just before market began pricing in the slower economic growth that the spread of the Covid-19 Delta variant brought about, writes Chris Senyek, chief investment strategist at Wolfe Research.
Secondly, the yield hit a 2021 high of 1.75% in March. With long-term inflation expectations above 2%, according to St. Louis Fed data, it’s more than conceivable that the yield can revisit that high.
The stocks that could benefit from such a rise are some of those most cyclical, or sensitive to the perceived short-term economic outlook.
The S&P 500 sector most correlated with long-dated bond yields: financials. Banks comprise a large portion of the sector, and when the difference between long-dated yields and short-term interest rates increases, banks can lend at higher rates and still borrow at low rates, boosting profitability. Plus, if economic growth is expected to be fairly strong, banks can make more loans. Since 2010, the S&P 500 financials sector has had a 66% correlation with the 10-year Treasury yield, according to Wolfe Research, the highest correlation out of all sectors on the index.
While the Financial Select Sector SPDR exchange-traded fund (ticker: XLF) has already risen back to around its 2021 high, the SPDR S&P Bank ETF (KBE) needs to gain just over 3% to revisit its 2021 high, set in March, when yields had peaked.
Capital-goods manufacturers and energy companies are also among the sectors most correlated sectors with the 10-year yield. Capital-goods producers in the index, such as Caterpillar (CAT), Boeing (BA), and General Electric (GE), make more machines for there customers when economic demand rises. The Industrial Select Sector SPDR ETF (XLI), which owns those stocks, is about 4% off its 2021 high. The Energy Select Sector SPDR ETF (XLE), which owns oil producers and oil-services firms, needs to gain about 7% to get back to its year high.
Rising yields could dent the stock market, but these sectors might be the best place to hide out in.
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