Rising Treasury yields are sapping rate-sensitive, income-generating sectors while providing a lift to the previously moribund financial services sector.
Until Aug. 31, 2016, rate-sensitive real estate investment trusts (REITs) are still part of the financial services, making parsing among the sector’s exchange traded funds, many of which feature significant REIT exposure, an important task as Treasury yields climb. [Classification Change Coming for REITs]
That much has been proven in recent weeks as the Financial Select Sector SPDR (NYSEArca: XLF) is up 1.3% over the past month while the iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) is lower by 3.4%.
Doubters might be apt to contest that the Fed delaing a rate hike would pressure some corners of the sector, including rate-sensitive insurance providers and regionayl banks. Those companies have been longing for higher interest rates after years of dealing with depressed net interest margins. [Bank on Bank ETFs]
The doubters cannot deny the SPDR S&P Bank ETF (NYSEArca: KBE) is up nearly 2% over the past month and that the $2.56 billion ETF hit a seven-year high Monday.
“Banks have outperformed REITs by ~25% since the February lows when both US interest rates andthe 5-30 Treasury yield curve bottomed out. At this point, the Banks are trading two standard deviations above REITs on the one-year regression line,” according to Rareview Macro founder Neil Azous.
Though not a dedicated regional bank of the same ilk as the SPDR S&P Regional Banking ETF (NYSEArca: KRE), KBE is regional bank-heavy. KBE allocates over 77% of its weight to regional banks and that is important when remembering KRE’s holdings have an average beta of +0.44 to moves in the US 10 Year Treasury. [A Breakout for Regional Bank ETFs]
Higher long-term rates help the sector since many banks borrow at short-term rates and lend at long-term rates, capitalizing on a widening spread.
“If you believe that the Federal Reserve is on hold in part due to the weak data as sketched out above and the search for yield will trump the net interest margin (NIM) argument on a steeper yield curve,then getting long on IYR and short of KBE makes more sense than just buying KBE outright on a relative rotation at the sector level,” adds Azous.
Some investors are already heeding that advice. As the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) has lost $580.5 million since the start of the current quarter, IYR has lost more than $1.5 billion while investors have added $36.7 million to KBE.
SPDR S&P Bank ETF