Changing Treasury Yields And Common Misperceptions

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Citi Research analyst Tobias M Levkovich takes a look at investment strategies in a scenario of hardening yields in his research report ‘Hunting for Treasure in Changing Treasury Yields.’

“There is an expectation that bond yields will be moving up over time when comparing the current yield to those provided by the five-year futures contract.”

Bond yields and inter-sector trading opportunities

Strong correlation is observed in bond yields versus certain relative sector performances, for example,

–       Tech relative to Telecom Services vs 10-year Treasury (inverse correlation)

1-tech rel to telecom

–       Industrials relative to Utilities vs 10-year Treasury (inverse correlation)


–       Materials relative to staples vs 10-year Treasury (positive correlation)


When will rising rates and yields crush equities?

The analyst agrees that it is entirely possible that equities will feel the pain of rising yields at some time, but suggests that this common concern should be viewed in the context of inflation. Encouragingly, inflation appears to be ‘non-existent’ given the soft labor markets such as in Europe and the U.S.

4-university of mich-inflation-expectations

Secondly, in the context of the new levels of national indebtedness ($17T), all bets are really off on the assessment of the likely ‘tipping point’ of yields versus equities.

The massive national debt apart, other factors make it difficult to set up a set of rules for playing equities in a rising yield scenario. Earlier thumb rules such as linkages of the commodities super cycle to a voracious appetite from emerging markets no longer apply. The shale gas revolution has changed forever the long-standing equations in the energy space. Financial institutions can no longer play the markets being hamstrung as they are by the new regulatory strictures.

A likely scenario

However, and this is significant, using a normalized earnings yield gap approach, it appears likely (>90%probability) that the markets could move higher over the coming year.

5-earnings yield-treasury

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