Steeper My Curve To Thee

Stock Market Impact

What will the stock market impact be if both parts of the supposition above -- higher 10-year-note yields and a steeper yield curve -- come to pass? Let's return to an analysis first introduced in February 2005 on assessing the impact of factor prices on S&P industry groups, and add the twist introduced in November 2006 on weighting these factors by the groups' representation in the index. Through these, we can construct tables of groups both helped and hurt by rising 10-year-note yields and a steeper yield curve at 90% confidence intervals.

First, let's take a look at the group impact of a steeper yield curve. There are a total of 20 groups with a negative beta to the yield curve; they underperform the S&P 500 as the yield curve steepens. They account for 12.22% of the SPX by weight and have a beta-weighted impact of -5.59%. These groups are concentrated in industrial sectors, which is not surprising at all given the association between a steep yield curve and a weak economy.

There are 11 of these groups with a statistically significant positive relationship to the yield curve accounting for 13.83% of the SPX by weight. Their beta-weighted impact is 7.11%, which brings the net impact of a steeper yield curve up to 1.52%. The distribution of these groups is somewhat surprising. Instead of being concentrated in carry-dependent financials, they are concentrated in the energy sector. If the forecast made two weeks ago for rising crude oil prices is correct, the oil stocks will benefit twice over.

We can repeat the exercise for 10-year-note yields themselves. A total of 14 groups accounting for 8.54% of the SPX are hurt by rising yields; their beta-weighted impact is a -0.73%. A total of 16 groups accounting for 11.40% of the SPX outperform when yields rise; their beta-weighted impact is 0.84% for a combined net impact of 0.11%. This latter number is shockingly near zero for a variable, long-term interest rate that is supposed to be so important to equities.

But the pattern of losers is clear: Stay away from financials, housing-related stocks and electric utilities. Those very same industrial firms that were hurt by a steeper yield curve within a weaker economy should do relatively well if 10-year-note yields rise.

The trend of long-term interest rates has been down for so long, since 1981, we forget what "up" looks like. As much of the equity bull market of the 1980s was really a bond rally in disguise, and as so much of the post-2002 rally has been a capture of liquidity, we forget that stocks often have to swim upstream against bonds for long periods. If that is going to be the case, do it with energy and industrials and stay away from the financials.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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