Last week, during our initiation on the Consumer Staples sector, we suggested that some investors have been involved in the sector in an effort to chase yield, given that lack of yield in other investment vehicles. In this note, we expand our original analysis of the XLP to include the Utility sector (XLU), another sector whose constituents enjoy stable and consistent cash flows and pay out a significant portion of those cash flows to investors in the form of dividends. As one would suspect, the XLU has seen some of the same anomalous behavior relative to history that we pointed out
regarding the XLP. In fact, the recent correlation of the price of the XLU and the 10 year yield is higher (r2 = 0.5485) that that of XLP versus the 10 year (r2=0.4836). Both sectors correlation to the yield of the 10 year is a relatively new phenomenon (since 2009) and represents a break with historical trends.
Unsurprisingly, the difference between the yield of the XLU and the yield of the XLP has been remarkably consistent since the beginning of 2009, with an average of 1.42% (the XLU has the greater yield) with a standard deviation of 0.22% - very stable. The yield spreads of each sector versus the yield of the 10 year are stable in relationship to each other as well – this makes sense intuitively as investors wouldn’t likely see a need to shift between the XLP and the XLU, but rather to simply look at the yield of each index in relation to the yield of the 10 year.
With regard to the price of each index, we were hoping for some predictive ability in terms of price movements, but were disappointed. Peaks and troughs for the two sectors occurred simultaneously or with inconsistent leadership by sector. Intuitively, the XLU, with the higher yield, should have been more sensitive to changes in the 10 year – this turned out not to be the case.
What was the case (again, unsurprisingly), was that the price movements for the two sectors were highly correlated (r2 =0.9259), lending significant support to our view that both sectors have seen significant inflows as investors search for yield in a yield-less world. At the same time, we have seen the multiple of the consumer staples sector creep upward. We believe that this increases the risk for fundamental investors in the staples sector, to the extent that fund flows are being dictated by circumstances unrelated to business fundamentals - it would not surprise us at all that at a point when investors should start to see improvement in the underlying business as the broader economy recovers, money flows out of the sector as rates creep upward. This will likely be in addition to any sector allocation strategies that might favor more recovery-oriented sectors.
In summary, our analysis shows that the XLU does indeed display the same anomalies with respect to investors chasing yield the past several years as does the XLP, and this phenomenon increases the risk for fundamental investors in both sectors.
Robert Campagnino
Managing Director
HEDGEYE RISK MANAGEMENT, LLC