Ten-year Treasury yields fell Thursday, but that does not alter the fact that those yields are up 6.3% this year. More staggering is the yield’s surge since the Feb. 2 bottom, one equivalent to about 60 basis points or over 37%.
Those rising yields have sent investors scampering out of exchange traded funds with exposure to rate-sensitive assets and sectors. To its credit, the Utilities Select Sector SPDR (NYSEArca: XLU) has mustered a decent 90-day gain of 3.6%, but the largest utilities ETF is still down 8.5% this year. That makes XLU the worst of the nine sector SPDRs after it was the best of the nine last year with a gain of 28.7%. [Sticking With Utilities ETFs]
Real estate investment trusts (REITs) and the related ETFs have also done precious little to enthuse investors. For example, the iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) is down 3.2% this year after climbing 26.7% this year.
Those declines have sent investors heading for the exits. Year-to-date, XLU has shed almost $619 million in assets. IYR is lighter by $1.56 billion while the Vanguard REIT ETF (NYSEArca: VNQ), the largest REIT ETF, has lost $500 million. Translation: Disdain for ETFs like IYR and XLU could be reaching extreme levels, signaling that a buying opportunity could be afoot. [Crunch Time for Rate-Sensitive ETFs]
“Since US yields peaked in September of 2013, the ratio of the SPDR S&P 500 ETF (NYSEArca: SPY) and US Real-Estate Trust ETF (IYR) is now two standard deviations above its regression line (i.e. yield-sensitive underperformance). This is now the third time this has happened during that time frame,” said Rareview Macro founder Neil Azous in a note out Thursday. “The last two times this happened, the S&P 500 (SPX) had plateaued and sold off in excess of 6% from peak to trough.
As Azous highlights in the charts below, SPY’s ratio of outperformance relative to IYR and XLU is flirting with the 2013 highs. If those ratios break higher, that would be good for SPY and trouble for IYR and XLU.
However, with 10-year yields residing near 18-month highs, IYR, XLU and related are presenting investors with the opportunity for a mean reversion trade. Savvy, risk-tolerant investors can also consider a pair trade of long XLU and/or IYR, short SPY.
Given the sensitivity of IYR and XLU to Treasurys, the trade should be a winner if yields ebb. IYR has the highest sensitivity to a constant maturity 20-year bond while XLU has the highest sensitivity to the equivalent 10-year bond, according to Rareview Macro.
Charts Courtesy: Rareview Macro