It’s a popular narrative that low bond yields have pushed investors into certain sectors of the equity market that offer higher yields than what they could receive from fixed income. This seems certainly to be the case in the U.S. where REITs, consumer staples, and especially utilities have been the beneficiaries of this trend.
All one needs to do is compare the two-year trailing daily price performance for these sectors versus the 10-year Treasury yield to see this inverse relationship (i.e. as bond yields decline, given sector appreciates). To demonstrate this, I used sector ETFs (XLP for cons. staples; XLU for utilities; and VNQ for REITs) as proxies for those sectors. The graphs are very telling.
For consumer staples:
And, finally, utilities:
The daily price movements of these ETFs were inversely correlated with Treasury bond yields to the tune of -.31 for REITs, -.49 for consumer staples, and a whopping -.62 for utilities.
It’s easy to conclude, then, that historically low Treasury yields have played a part in forcing up valuations above their 20-year average, per JP Morgan:
(Note: In the chart above, JP Morgan also provides a correlation to Treasury yields, and their results are slightly different from mine, perhaps due to my use of sector ETFs.)
However, with government bond yields in Switzerland, Japan, and Germany now firmly negative, and rates generally lower all around the world, I wanted to see whether the same relationships existed between these sectors and low bond yields [Note: for methodology on composite yield construction see note at bottom]. The results were somewhat surprising.
First of all, just as with their American counterparts, foreign consumer staple stocks (as measured by the SPDR Int’l Cons. Staples ETF, IPS) have enjoyed a good run (and sport similarly elevated valuations), most likely the beneficiaries of almost non-existent global bond yields in their home countries. The 2-year daily correlation between the composite bond yield metric and international consumer staples has been -.40:
However, that is generally where the similarities end. For the most part, global REITs (as measured by Vanguard’s VNQI) have mostly followed yields down (correlation: .21):
Stunningly, just the opposite of American utilities, foreign utilities (as measured by the SPDR Int’l Utilities ETF, IPU) have actually been positively correlated with falling bond yields, .66.
What’s remarkable about this is that foreign utilities have generally the highest yields of any foreign equity sector, and their valuations are less than any sector save financials.
So what might explain the divergence between American and foreign utilities as well as between American and foreign REITs?
The REIT explanation is perhaps a little easier; the strong dollar of the last few years has generally corresponded with moves higher in domestic REITs while moving somewhat in the opposite direction of international REITs. Furthermore, VNQI is heavily exposed to lagging regions such as Japan (~25%) and China (~7%).
In the case of foreign utilities, the reasons for underperforming are not so easily explained. As noted in a previous post, utilities have been among the worst performing foreign sectors since 2008. Big chunks of the utilities ETF are from Italy (~11%), and Spain (~13%), the markets of which have lagged terribly since the 2007 top. But even that may not explain the divergence. While Germany has been one of the better-performing non-US markets since 2007, its utilities have lagged as well. Witness the shocking performances of large German utilities RWE (-67%) and E.On (-64%) over the last four years (data from Morningstar):
The takeaway here is that low rates can be an easy and probably overly simplified explanation for the returns of REITs, utilities, and consumer staples in the US. However, the relative and shocking underperformance of their foreign counterparts, – generally in countries with rates far lower than those in the US, and many in countries with rates even in negative territory, – lead me to believe that there is quite a bit more to the story. That, however, will have to be the subject of another post.
Note: To demonstrate more accurately the foreign sector performances versus relevant bond yields, I took the country weightings of each ETF (this information can be found on the fund companies’ websites) and built a composite index using yield data from investing.com.