The recent rise in benchmark bond yield has dampened enthusiasm for equities as it offers higher risk-free returns to investors. This has resulted in the broader equity market’s closing in the red for the last couple of trading sessions.
But, one shouldn’t completely shun stocks, specifically that of defensive companies. After all, these stocks provide risk-adjusted returns and steady earnings regardless of the state of the equity market.
US Bond Yields Have Been Creeping Higher
The 10-year U.S. Treasury note, a benchmark for interest rates rose 17.1 basis points or 0.171% last week — the sharpest weekly advance since February. The 10-year yield is now near the 3.23% mark, its highest in nearly seven years.
The benchmark bond yield had exceeded the 3% mark briefly in 2013 and January 2014, which was toward the end of the bond market wipeout, better known as the “taper tantrum.” Investment banking giant, The Goldman Sachs Group, Inc. GS in the meantime predicted that 10-year yield will jump 3.4% by 2019-end.
The broader equity market continues to fall as fears over spike in interest rates continue to weigh on investors’ sentiment. And why not? For a prolonged period of time, the equity market enjoyed a bull run, mostly due to ultra-low yields. But, now higher yields will result in steeper borrowing costs for both corporates and individuals. This has raised a lot of apprehension about investing in equities that are perceived as more risky compared to bonds. At the same time, equities are now already deemed lofty by some measures.
Why is Benchmark Bond Yield Surging?
This is because a slew of positive economic reports have reinforced expectations that the Federal Reserve will stick to its program of rising rates at a gradual pace (read more: Fed Issues Third Rate Hike of 2018: Top 5 Gainers).
The labor market is in excellent shape, with unemployment rate falling to a 49-year low of 3.7% in September, the lowest since December 1969, per the Labor Department. Another key barometer of the U.S. economy has hit post-recession high. The ISM services index climbed to 61.6% in September from 58.5% in August, its second-highest reading.
In fact, the overall economy has expanded at a seasonally adjusted rate of 4.2% in the April-June quarter, while most of the components of the Conference Board’s Leading Economic Index indicated a 3% or more growth rate in GDP in the final two quarters of the year.
Technical equity traders further added that bears were sitting on the sidelines and were ready to add to the selling pressure once the 10-year note breached the 3.11% to 3.12% area. And that’s exactly what happened when the 10-year yield crossed the technical support around 3.11%.
How to Play Rising Yields?
As the equity rout has worsened due to rising interest rates, defensive stocks have attracted bids. After all, these stocks are generally non-cyclical or companies whose performance and sales are not highly correlated with activities in the broader market. Their products are in constant demand irrespective of market volatility and such names include companies from utility and consumer staples sectors.
Utilities are deemed defensive stocks as electricity, gas and water are essentials. Food, beverage and tobacco companies, to name a few, are true defensive plays as demand for such staple stocks are immune to market gyrations.
4 Top Picks
We have, thus, selected four low-beta stocks from the aforementioned defensive sectors that boast a Zacks Rank #1 (Strong Buy) or 2 (Buy). Notably, low-beta stocks are less correlated to the index and thus tend to be less volatile. In this case, a low beta ranges from 0 to 1.
Algonquin Power & Utilities Corp. AQN owns and operates a portfolio of regulated and non-regulated generation, distribution, and transmission utility assets. It has Zacks Rank #2 and a beta of 0.76. The Zacks Consensus Estimate for the company’s earnings rose 3% in the last 60 days period. The company’s expected earnings growth rate for the current year is 17.2% compared with the Utility - Electric Power industry’s estimated rally of 8.6%.
Ameren Corporation AEE operates as a public utility holding company. It has Zacks Rank #2 and a beta of 0.2. The Zacks Consensus Estimate for its earnings rose 1.2% in the last 60 days period. The company’s expected earnings growth rate for the current year is 14.8% compared with the Utility - Electric Power industry’s projected rally of 8.6%.
The Chefs' Warehouse, Inc. CHEF distributes specialty food products. It has Zacks Rank #1 and a beta of 0.83. The Zacks Consensus Estimate for earnings rose 1.3% in the last 60 days period. The company’s expected earnings growth rate for the current year is 77.3% compared with the Food - Miscellaneous industry’s expected growth of 5.5%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Ollie's Bargain Outlet Holdings, Inc. OLLI operates as a retailer of brand name merchandise that offers food products. It has Zacks Rank #2 and a beta of 0.25. The Zacks Consensus Estimate for earnings rose 2.9% in the last 60 days period. The company’s expected earnings growth rate for the current year is 40.8% compared with the Consumer Products - Staples industry’s estimated decline of 1.7%.
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