Yields & utilities

September 22, 2015 01:00 PM

The yield on the 10-year U.S. Treasury note finally hit bottom, and found its way to a two-year low in early February 2015. Since that time, with expectations of the Fed’s impending rate hike and a strengthening U.S. economy, it’s been rising steadily. In these environments, so it goes, investors rotate out of sectors like utilities where the dividends start becoming less appealing, and out of assets like gold that provide no yield, and into areas like financials and insurers that directly profit from higher rates.

The inverse correlation between rising yields and falling prices of utility stocks seems solid and consistent. In fact, of all sectors, utility stocks have the lowest correlation to 10-year U.S. Treasury yields by far during the past six years.

What investors do not have a good gauge for is whether this holds true in all environments. What if yields are falling vs. rising? Does what’s happening in utilities because of other factors have an effect? What are the sizes of the moves in these different environments?

EidoSearch uses a patented numerical search engine to analyze patterns in data and to project outcomes based on the outcomes of similar patterns historically. We ran a study on the 10-year Treasuries and utilities, looking at the past two years’ price trend to find where both traded in a similar fashion at the same time. Any move by the Fed will certainly adjust the trend and therefore the forecast, but until then, here is a barometer on what to expect.

We found three statistically similar instances, with the current two-year price trend for both the 10-year (price) on top and Morningstar Utilities Sector Index on bottom, and the historical matches in black. On each chart is the forward six-month return after these instances.

Interestingly, out of the three most similar environments historically, in only 1994-1996 did utilities rise when yields dropped. In 1999 yields and utilities were both up in the next six months, and in 2008 yields and utilities were both down.

About the Author

Dr. Steven Zhang is the CEO at EidoSearch.com, a  Ph.D. in electronic engineering and an internationally renowned expert in information processing technologies. His expertise is in the areas of signal processing, multimedia content analysis, computational intelligence, pattern classification, as well as, applications in bioinformatics and finance.