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Advisors that have been in the game awhile, perhaps their sophisticated clients, too, may indulge in the following guilty pleasure: Assessing what sectors are inversely and positively correlated to interest rates.
As recent history confirms, financial services stocks are among the most positively correlated to rising rates while high dividend sectors, such as real estate and utilities, are vulnerable to higher borrowing costs owing to the capital-intensive nature of those industries.
Owing to longer duration cash flows, technology, though not to the extent of real estate and utilities, is also viewed as rate-sensitive. That much was on display in the first half of this year. As 10-year Treasury yields surged through much of the first half of this year, the tech-heavy Nasdaq-100 Index (NDX) dithered, returning just 4.4% from the start of the year through May 19.
The S&P 500 was higher by 11.8% over the same span. When 10-year yields retreated, NDX proved responsive in fashion and it's year-to-date gain is now an admirable 14.2%. Some clients will see those statistics and think it's best to ditch when bond yields are rising as is the case again today. However, there's more to the story.
History Is Useful, But Not Always Gospel
Advisors know something: The current environment is conducive to being correlation-aware, but, specific to tech and rising rates, historical precedent belies the notion that the sector is heavily driven by government bond yields.
“It turns out that when the numbers are crunched, over the past 15 years there has only been a small inverse correlation between technology stocks and bond yields. In other words, when bond rates rise, there is a slight tendency for tech stocks to fall,” according to Morningstar. “That was true also during the last time the Federal Reserve was raising interest rates, from late 2015 through the end of 2018.”
In plain English, tech's course isn't charted nearly as much by rates as, say, banks or utilities stocks. Data confirm as much.
“With a correlation of negative 0.33 between tech stocks and 10-year Treasury yields over the past 15 years, the inverse relationship is relatively low. When it comes to Treasury bill yields, there's almost no relationship,” adds Morningstar.
In many regards, those data points are pluses for advisors because with economic growth poised to slow, growth stocks could come back into style. Additionally, clients want tech exposure and those in younger demographics can wait out any punishment the sector may incur at the hands of rising rates. However, as the aforementioned data indicate, that scenario may not arrive at all.
Key Point of Differentiation
Something else to discuss with clients is exactly how their tech exposure shapes up against the backdrop of rising rates. For example, mature tech companies – say Apple (NASDAQ:AAPL) or Microsoft (NASDAQ:MSFT), are less sensitive to rising rates than are smaller, younger tech companies.
Apple and Microsoft are making plenty of money today, but smaller companies with future, not-yet-arrived earnings are vulnerable to lower discount rates. However, that doesn't mean abandoning disruptive growth strategies altogether is a recipe for rising rates for success.
“What about that slide by disruptive growth stocks and funds when rates were rising in the first half?,” you say. Well, that decline probably wasn't entirely attributable to rising 10-year yields.
“"Tech stocks may have simply been due for a pullback," Brian Colello, Morningstar technology sector director, said. "Tech was one of the stronger sectors in 2020 during the pandemic and generally outperformed the broader market. This led to many overvalued stocks at the start of 2021. It's possible that the latest pullback might simply be a healthy breather."