Metric loss

This popular bond market metric will be your guide to trading stocks in 2022

Keeping a close eye on bond market metrics can help investors’ stock strategies for 2022 – Photo: Shutterstock

Investors can learn a lot from the bond market about which stocks and sectors are likely to thrive or struggle this year.

The 10-year Treasury yield – one of the most popular and widely used measures to track the evolution of interest rates and inflation in the economy – shows a substantial correlation with the performance of US sectors specific, whether for better or for worse.

The dizzying jump in bond yields, spurred by hawkish moves by major central banks and lingering inflationary pressures, has propelled volatile stock market performance year-to-date, with some sectors outperforming others significantly.

The yield on the US 10-year note has risen from 1.5% at the end of 2021 to almost 2% recently.

Over the same period, energy and financial stocks jumped 18% and 4% respectively, while technology stocks fell 7% and real estate and communication services 8%.

In an environment of rising interest rates and persistently high inflation around the world, an understanding of the link between bond yields and sector performance can provide a very useful guide to trading stocks in 2022.

What is the relationship between US equity sectors and Treasury yields?

One of the most important things to understand for successful stock trading is how a stock or sector might behave when US Treasury rates change.

We analyzed the weekly relationship between the relative performance of an equity sector (versus the S&P 500 index) and 10-year US Treasury yields using the statistical measure of correlation. We used three distinct periods: 20 years, 10 years and five years.

Here are the main conclusions:

  • Financials (XLF) and energy (XLE) stocks show the strongest correlation (with a coefficient of 0.9 and 0.86, respectively, for the past five years) with 10-year US Treasury yields. This means that as bond yields rise, these sectors tend to outperform the S&P 500 Index, and vice versa.
  • Industrial stocks (XLI) have reversed their negative correlation with Treasury yields, showing a positive and robust relationship (measured by a correlation coefficient of 0.81) with the 10-year yield over the past five years. Therefore, industrial stocks can also benefit from an environment of rising bond yields, while they could struggle when yields fall.
  • The Utilities (XLU) and Consumer Staples (XLP) sectors have increasingly lost their relationship with Treasury rates and have been uncorrelated to the bond market over the past five years.
  • The healthcare sector (XLV) has historically moved in the opposite direction to Treasury yields, given the negative correlation between the two. However, the strength of the association was significantly reduced, from -0.83 when looking at the 20-year correlation to -0.28 when looking at the previous five years.
  • The technology sector (XLK) has the strongest negative link with 10-year Treasury yields (-0.79 for the last five years). All other things being equal, any increase in Treasury yields causes the tech sector to underperform the general stock market.

Correlation between US equity sectors and 10-year Treasury yields

SECTOR TELEPRINTER

Correlation coefficient with
US 10-year yields
(last 20 years)

Correlation coefficient with
US 10-year yields
(last five years)

Correlation coefficient with
US 10-year yields
(last five years)

Energy XLE/SPX 0.11 0.50 0.90
finance XLF/SPX 0.85 0.61 0.86
Industrial XLI/SPX -0.72 0.55 0.81
Materials XLB/SPX -0.37 0.42 0.51
Real estate XLRE/SPX 0.16
Basic consumption XLP/SPX -0.81 0.02 0.09
Utilities XLU/SPX 0.62 -0.11 0.09
Health care XLV/SPX -0.83 -0.15 -0.28
Communication Services XLC/SPX -0.51
Consumer Discretionary XLY/SPX -0.82 -0.37 -0.62
Technology XLK/SPX -0.76 -0.56 -0.79

Credit: Capital.com; Data: Tradingview

Why do energy and financial stocks move in line with Treasury yields?

a chart showing the high correlation between energy and banking stocks with US Treasury yieldsEnergy and financial performance vs US 10-year yields – Credit: Capital.com / Source: Tradingview

For financial firms such as banks, higher Treasury yields may imply that higher interest margins will be passed on to borrowing costs for consumers and businesses. The prospect of higher interest rates on loans granted by banks leads to higher expected profits.

The rise in US bond rates has no direct impact on energy stocks. Higher Treasury yields, on the other hand, are often a symptom of rising inflation, which could be caused by rising global energy prices, such as crude oil and gas. High energy prices can lead to higher profits for energy companies.

Why are rising bond yields hurting tech stocks?

Nasdaq vs S&P 500 and US 10-Year YieldsNASDAQ ratio on S&P 500 and US 10-year yields – Credit: Capital.com / Source: Tradingview

Technology stocks (XLK) are also referred to as “growth stocks” because investors generally expect strong future earnings growth from technology companies, reflecting their high market valuation.

Tech stocks tend to move inversely to 10-year yields because they are used to discount the value of future cash flows.

All other things being equal, any increase in Treasury yields results in the sector underperforming the broader stock market.

As the chart above shows, the Nasdaq 100 Index, the mirror image of tech stocks, underperformed the S&P 500 Index at a time when the yield on the US 10-year note was soaring.

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