With 10-year Treasury yields down 16% this year, the specter of higher interest rates may not be on every investor’s mind, but failure to prepare is preparing to fail.
That said, investors can prepare for rising rates right by, at the very least, studying which sectors prove durable during cycles of Federal Reserve tightening. By way of Josh Brown at The Reformed Broker, Bank of America Merrill Lynch’s U.S. Equity and Quantitative Strategist Savita Subramanian shows investors that “during the last three Fed rate tightening cycles, Consumer Discretionary consistently underperformed the market.”
Not surprisingly, telecom and utilities stocks with a highly negative correlation to interest rates “have also underperformed during several Fed tightening cycles with the exception of 2004-2006,” according to Subramanian.
The vulnerability of the utilities sector to higher rates was on display last year. As 10-year yields surged, the Utilities Select Sector SPDR (NYSEArca: XLU) rose just 13% compared to a 32.3% gain for the S&P 500. [Utilities Could Survive Rising Rates]
Of course past performances are not guaranteed to repeat, but looking at the 2004-2006 Fed tightening cycle could prove constructive for generating sector bets with ETFs for the next time the Fed raises rates.
The S&P 500 rose 34.5% from the start of 2004 through the end of 2006 with theTechnology Select Sector SPDR (NYSEArca: XLK) and the Health Care Select Sector SPDR (NYSEArca: XLV) among the most notable laggards. In fact, XLK and XLV’s combined returns over that tightening cycle barely exceed those of the S&P 500. [Secrets of Cyclical ETFs]