As we highlighted (HERE), recent economic data reinforces that too strong inflation is a larger source of market risk than is a potential weakening of economic demand. Under this backdrop higher 10yr yields should be associated with weaker markets and vice versa.
That theory matches what we see within market internals. Across the S&P 500, beta dispersion to the 10yr yield has converged sharply versus the 2018–2021 period, and the convergence is asymmetric. What that means is that higher yields are likely to have stronger negative impact on yield sensitive names than lower yields would benefit those with negative sensitivity.
At the industry group level, more than half of the S&P has negative sensitivity to the 10yr yield, and essentially all show more negative sensitivity than normal. Higher realized sensitivity confirms that a “higher yields are bad for risk assets” playbook is appropriate today.
At the factor level, the risk-on/risk-off split is sharp, and Low Volatility is the clearest casualty of higher yields. As we highlighted in our previous report (HERE), Low Volatility has seen a prolonged period of declines. The factor’s extreme negative sensitivity to yields means returns to the factor will remain volatile around inflation releases. The next data on price levels are out this week with CPI on 5/12 and PPI on 5/13.
All of the above suggests investors focus on names with high economic sensitivity AND low debt sensitivity. As we highlighted (HERE), our economic and debt sensitivity screening captures names that enjoy the tailwind of rising PMIs while avoiding the potential volatility tied to yield uncertainty. YTD, High Economic Sensitivity and Low Debt Cost Sensitivity returns materially exceeds that of our other Eco/Debt Sensitivity groupings. Across all groupings, returns are better to low debt sensitivity names.
Yield Sensitivity is High and Asymmetric Ahead of Inflation Data: As we highlighted (HERE), the U.S. is in its 26th consecutive month of a Normal economic expansion regime with a 0% chance of being in or near a recession. Today’s forward yield curve is common in Normal regimes – the yield curve is stable and flat. The level of yields is below the 50th percentile of all four regimes at every tenor from 3m to 10y.
At the same time, across the S&P 500, beta dispersion to the 10yr yield has converged sharply versus the 2018–2021 period, and the convergence is asymmetric – the positive side has collapsed more than the negative side. The lowest decile of S&P names has more negative betas to yields than highest decile has positive. Higher yields are likely to have stronger negative impact while lower yields would provide a more modest boost to winners. That is consistent with the lower yield winners being more thematically driven in today’s backdrop.
John Roque, 22V’s head of Techincal Analysis, highlighted 5% as the top end of the range for the US 10-Year Treasury Yield. If productivity readings remain strong and inflation data do not surprise to the upside, 10yr yields should remain below 5% and be biased lower over time. That being noted, strong inflation readings or further geopolitical shocks that push 10yr yields higher would mean downward pressure on risk assets.
Industry-group sensitivity confirms the high-yield headwind is broadening, not localized. All 13 S&P 500 industry groups currently exhibit negative sensitivity to the 10yr yield and greater negative sensitivity than normal. Realized sensitivity confirms that any further rise in yields would impose a stronger headwind than these groups have typically faced. The only industry groups showing more positive sensitivity than normal are Energy, Semis, Software, and Tech Hardware. Those groups also have low macro influence, so the direction of the 10yr is less relevant.
At the factor level, the risk-on/risk-off split is sharp, and Low Volatility is the clearest casualty of higher yields. Risk-on factors (Liquidity and Earnings Turbulence) lead the positive sensitivities to the 10yr yield, while risk-off factors (Quality of Earnings and Low Volatility) lead the negative sensitivities. Low Volatility stands out as the clear outlier — significantly negatively exposed to both long-term and short-term yields. As we highlighted in our previous report (HERE), Low Volatility has seen a prolonged period of declines. The factor’s extreme negative sensitivity to yields means returns to the factor will remain volatile around inflation releases.
All of the above suggests investors focus on names with high economic sensitivity AND low debt sensitivity. As we highlighted (HERE), our economic and debt sensitivity screening captures names that enjoy the tailwind of rising PMIs while avoiding the potential volatility tied to yield uncertainty. High Economic Sensitivity and Low Debt Cost Sensitivity YTD return materially exceeds that of our other Eco/Debt Sensitivity groupings. Within the two High Economic Sensitivity baskets, the Low Debt Cost Sensitivity basket outperformed WoW and YTD; and within the two Low Economic Sensitivity baskets, the Low Debt Cost Sensitivity variant also outperformed.
