Rising yields: Impact on sectors

With U.S. long-term interest rates trending higher, a question equity investors might be asking themselves is which stocks and sectors could be affected most?

One way of analyzing the problem is to look at the historical correlation (derived from rolling 36-month windows) between monthly S&P 500 index sector returns and changes in 10-year U.S. Treasury yields.

Roughly speaking, correlation measures the degree to which two sets of data points track one another. When they are positively correlated, respective changes for each period tend to have the same sign (i.e., plus or minus); when they are negatively correlated, the opposite holds true. The higher the value in absolute terms, the tighter the connection.

Up until the spring of 2003, it would have been difficult to arrive at a clear-cut answer, as the various sector-yield correlations were somewhat in synch.

Since then, however, correlations have diverged somewhat, with the utility and materials groups (which have equivalent exchange-traded funds, or ETFs (AMEX: XLU and XLB, respectively)) currently at opposite ends of a widening spectrum. That is, when yields have been rising, there has been a modest downward bias in monthly utility sector returns and a modest upward bias in materials sector returns.

Under the circumstances, a further increase in long-term interest rates (i.e., continued falling bond prices) could see the utility sector, which has already been slammed in recent weeks, under further pressure, while materials shares may offer a degree of refuge. Of course, one should always bear in mind that interest rates are not the only influence on stock prices.

Michael Panzner is a 25-year veteran of the global stock, bond, and currency markets and the author of Financial Armageddon: Protecting Your Future from Four Impending Catastrophes and The New Laws of the Stock Market Jungle: An Insider's Guide to Successful Investing in a Changing World.