THEYields on longer-dated global sovereign bonds have rebounded sharply from their recent summer sluggishness. The 10-year US Treasury yield climbed 30 basis points from its recent September low of 1.26% to a three-month high of 1.56% on September 29.

Additionally, it also staged a bullish breakout of a six-month corrective drop in place from the March 30 high of 1.77% and returned above its 50-day moving average. These observations suggest a likely continuation of its current major uptrend phase from its pandemic-induced capitulation low of 0.33% printed on March 9, 2020 to test its next key resistance at 1.95% over the coming months. in the fourth quarter.

10-year US Treasury yield

New upside potential to 1.95%

Source: TradingView (click to enlarge the chart)

What is interesting is that the economic environment associated with this recent episode of rising sovereign bond yields is different from the previous strong rebounds seen earlier in the first quarter. During the first quarter, the previous upward movement seen in the yield of the 10-year US Treasury was presented as a reflation theme where the Covid-19 vaccination roll-out program began to gain traction and massive expansionary fiscal policies added another form of “liquidity-taking” to the markets; The US Congress passed a $ 900 billion stimulus and relief bill in late December 2021. All of these measures were seen as positive growth that supported the recovery process after a severe economic downturn triggered by the pandemic in a short time. As a result, cyclical stocks such as industrials, financials, energy and materials outperformed in the first quarter, in line with the rally seen in the 10-year US Treasury yield, while technology stocks underperformed. .

In contrast, the current economic environment has been bogged down by the “maximum growth” narrative where the growth of manufacturing and service activities in developed countries, including China, has stagnated or contracted, a decline in the consumer confidence, higher inflationary pressures, including food, due to a persistent environment of global supply chain disruptions and, more recently, the global energy supply crisis which triggered a another round of sharp increases in oil prices.

Thus, the current recovery seen in longer-term sovereign bond yields is now associated with a weaker economic growth environment, with the lack of additional liquidity flowing into the markets as most central banks in developed countries, including the Fed, have provided clear indications to start reducing their respective massive quantitative easing programs before the end of 2021 and a higher inflationary environment that does not appear to be transitory in nature.

Given that monetary policies are now becoming less accommodating and the next source of liquidity to quench thirst for risky assets such as stocks will be fiscal stimulus policies. Passage of the US administration’s $ 3.5 trillion additional infrastructure spending bill is now in limbo as the differences in spending priorities have yet to be resolved between the two countries. different factions of the Democratic camp.

Therefore, it is likely that this time around we are witnessing a potential theme of stagflation rather than reflationary. The next question is who will be the potential winners and losers in terms of US stocks in the current context of rising 10-year US Treasury yields?

Let’s look at this table below which highlights the performance of the 11 S&P sectors (data obtained from their respective SPDR Select Exchange Traded Funds), 20-day sliding correlation of sector movement with the 10-year US Treasury yield. and the respective sectors’ 12-month forward P / E ratios.

Source: TradingView as of October 5, 2021, FactSet P / E ratios as of October 1, 2021 (click to enlarge the graph)

Potential winner

Energy sector recorded the highest one-month yield of 13.20% along with a significant positive 20-day correlation coefficient of 0.90 with the 10-year US Treasury yield, suggesting that the SPDR Select Energy Sector ETF tends to see a similar directional movement with the 10-year US Treasury yield. The correlation coefficient is a statistical measure of the strength of the linear relationship between two different variables that ranges from a minimum value of -1 to a maximum value of +1.

Another link to its very positive correlation reading with the 10-year US Treasury yield is via higher oil prices which tend to reinforce inflationary pressures which in turn can be one of the factors that trigger a news. higher yields on longer-term global sovereign bonds observed in the past one month. In addition, a bullish oil market can increase the profit margins of US energy-related companies.

In addition, the 12-month forward P / E ratio of the energy sector is relatively less expensive in terms of valuation compared to the 12-month forward P / E ratio of the benchmark S&P 500 and is trading at a discount of -32.84%, the lowest among the 11 sectors. . The five main stocks making up the SPDR Select Energy Sector ETF in terms of weighting are Exxon Mobil, Chevron, Schlumberger, ConocoPhillips and EOG Resources.

Potential losers

Information Technology Sector is vulnerable in an environment of rising longer-term US Treasury yields due to higher valuation risk. Its 12-month forward P / E ratio trades at a + 24.88% premium over the S&P 500’s 12-month forward P / E ratio and is the second highest among the 11 sectors.

In addition, a further potential rise in the 10-year U.S. Treasury yield implies an increase in long-term interest rates which may hamper larger-scale share buyback programs due to the higher funding costs to initiate. such programs. The information technology sector recorded the highest amount of second-quarter share buybacks among the 11 sectors, with a value of $ 62.8 billion.

Besides, SPDR Select Information Technology Sector ETF’s The 20-day correlation coefficient stands at a significant level of -0.70 with the 10-year US Treasury yield, indicating that a further increase in the movement of the 10-year US Treasury yield should lead to a further increase in the movement of the 10-year US Treasury yield. fall in the share price of SPDR Select Information Technology Sector ETF. The top five stocks of the SPDR Select Information Technology Sector ETF in terms of weighting are Apple, Microsoft, NVIDIA, Visa and Mastercard.

Real estate sector has a significant concentration in REITs which tend to be under downward pressure in the short to medium term in a rising interest rate environment. REITs distribute a constant stream of periodic dividend payments to investors and are considered to compete for capital flows with similar constant periodic payments of “risk-free” coupons from bonds or US Treasury notes.

Thus, a bullish 10-year US Treasury yield coupled with a lackluster economic growth environment is likely to increase the opportunity costs of investing in REITS versus less risky Treasuries, which in turn will lead to a potential revaluation. of REITS stock prices at the downside.

The above-mentioned inverse relationship between REIT stock prices and Treasury bill yields can be supported by data where the recent 20-day correlation coefficient of SPDR Select Real Estate ETF with the 10-year US Treasury yield is at a significant level of -0.91, the highest among the 11 sectors. The five main stocks making up the SPDR Select Real Estate ETF in terms of weighting are American Tower Corp REIT, FPI Prologis Inc, Crown Castle Intl Corp REIT, FPI Public Storage and Simon Property Group Inc REIT.


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