Bond Proxies Suffer as Soaring Treasury Yields Shake U.S. Equity Market
The recent surge in Treasury yields has sent shockwaves through the U.S. equity market, particularly impacting a group of stocks known as bond proxies. Since the Federal Reserve’s hawkish interest rate projections last month, which pushed U.S. yields to 16-year highs, the S&P 500 has experienced a 4% decline from its late July peak. While rising yields generally have a negative impact on growth stocks, the steepest losses have been concentrated in traditionally stable sectors such as utilities and consumer staples.
These sectors, often referred to as “bond proxies,” have been favored by investors for their strong and stable dividends, which have typically exceeded Treasury yields over the past decade. However, the recent surge in bond yields has diminished the appeal of these bond proxies. Government debt is now offering higher yields that are perceived as virtually risk-free when held to term. For instance, the yield on a six-month Treasury stands at around 5.6%, while the utilities sector yields 4% and staples yield 3%, according to LSEG data.
As a result, shares of bond proxies have experienced significant losses in recent weeks. The S&P 500 utilities sector has tumbled 13% since the Fed meeting, while staples have dropped about 8%. Other dividend-focused areas, such as real estate and telecom stocks, have also suffered declines.
Investors have been forced to readjust their portfolios following the Fed’s outlook, which suggests that interest rates will remain higher for an extended period. This outlook has also strengthened the dollar and caused gold prices to slide. The underperformance of bond proxies indicates that the market is acknowledging a shift in the interest rate regime, according to Irene Tunkel, chief U.S. equity strategist at BCA Research.
The upcoming consumer price index report and third-quarter earnings results for U.S. companies, including major banks, will be critical in determining the near-term path for stocks. Despite the recent pullback, the S&P 500 has still recorded a 10% gain for the year. The utilities sector, in particular, has garnered investor attention due to its steep slide. However, some investors see this weakness as an opportunity, as the sector is currently trading at its lowest relative valuation to the S&P 500 since 2010, excluding the initial coronavirus period in 2020.
Retail investors have shown interest in utilities shares, with a significant influx of $32 million in a recent five-day stretch, according to data from VandaTrack. The decision to invest in these stocks may depend on an investor’s outlook for interest rates. James Ragan, director of wealth management research at D.A. Davidson, suggests that if one believes the 10-year yield will continue to rise, utilities may not perform well.
In conclusion, the recent surge in Treasury yields has had a significant impact on bond proxies, causing losses in traditionally stable sectors such as utilities and consumer staples. Investors are closely monitoring upcoming economic reports and earnings results to gauge the future direction of the market. Despite the recent pullback, some investors see the weakness in utilities shares as an attractive opportunity due to their low relative valuation.