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Sector ETFs to Win/Lose Amid Surging Treasury Yields

Wall Street has been upbeat in the first half of 2023 despite a few occasional hiccups, mainly due to a less-hawkish Fed, better-than-expected corporate earnings and the AI mania. However, Wall Street’s run in the second half of the year hasn’t been smooth so far as rates have been rising.

The U.S. Treasury yields have been on a surge lately, driven by expectations that the Fed will keep interest rates higher for longer to fight inflation. The U.S. jobs market has been hot despite higher rates while U.S. consumers have been resilient despite high inflation. This may lead the Fed to enact one more rate hike in November this year.

As of Oct 19, 2023, the benchmark U.S. treasury yield stood at 4.98%, up from 4.69% recorded at the start of the month. Given this, investors must be interested in finding out which equity sectors perform well and which sectors perform poorly amid rising interest rates. Let’s find out.

Winning Sectors

Insurance – iShares U.S. Insurance ETF (IAK)

Insurance companies normally invest a considerable portion of their premium revenue in various safe financial instruments, including treasury bonds. They do this to generate investment income that can help cover claims and operational expenses.The yield on these bonds is a key determinant of the investment income the insurance companies earn. Moreover, more car and home purchases are seen in a steadily recovering economy, which indicates more policy writing.

Consumer Staples – Consumer Staples Select Sector SPDR ETF (XLP)

This sector is defensive in nature and known for its durability.  The demand for the consumer staples sector remains consistent across all types of economies, even in the face of rising interest rates. Companies in the consumer staples sector normally witness relatively stable cash flows. This stability can provide a buffer during economic challenges and help companies to continue operating and paying dividends to investors. The fund XLP charges 10 bps in fees and yields 2.78% annually.

Losing Sectors

Utilities – Utilities Select Sector SPDR ETF (XLU)

Though the sector is defensive in nature and known for its resilience, the sector typically underperforms in rising rate environment. The sector is capital-intensive in nature, as interest rates increase, the cost of borrowing for utilities companies also rises. Higher borrowing costs can erode profit margins and potentially limit their ability to invest in new projects. Utilities stocks offer sizable dividends. But rising interest rates can make fixed-income investments more attractive compared to utility stocks.

Real Estate – Vanguard Real Estate ETF (VNQ)

The real estate sector is significantly influenced by changes in interest rates. Rising interest rates typically lead to higher mortgage rates. This can make it pricier for homebuyers to finance their purchases, potentially reducing demand for residential real estate. Real estate stocks are also known for higher payouts. The fund yields 4.81% annually. But this yield is lower than the current U.S. benchmark treasury yield. A yield generation, which is lower than the U.S. benchmark treasury, is another negative for the real estate fund.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

Vanguard Real Estate ETF (VNQ): ETF Research Reports

Consumer Staples Select Sector SPDR ETF (XLP): ETF Research Reports

Utilities Select Sector SPDR ETF (XLU): ETF Research Reports

iShares U.S. Insurance ETF (IAK): ETF Research Reports

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Zacks Investment Research