Must-know: Is the utilities sector a bond market proxy?

Russ Koesterich, CFA - Author

Nov. 20 2020, Updated 11:19 a.m. ET

Bond market proxies (such as the utilities sector and REITs) look particularly vulnerable in an environment of rising real rates (It’s important to note that higher real yields, not rising inflation, are driving today’s higher nominal yields as investors are demanding more compensation for holding bonds). Instead, I prefer select cyclical sectors such as energy and technology.

Market Realist – The chart above shows that the utilities sector (XLU) moves in a similar path of bond (BND) prices. So the utilities sector gives investors bond-like exposure.

As we’re heading into a high interest rate regime, a portfolio containing both bonds and the utilities sector could backfire, as both underperform in such scenarios. Also, such a portfolio wouldn’t be well diversified.

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Cyclical sectors like energy (XLE) and technology (QQQ)(XLK), on the other hand, could be better bet currently. Both these sectors have rich valuations, trading around 14x and 20x times their respective earnings, and you can make a case for both. As the U.S. economy continues to grow, inflation rates too can increase. The energy sector is a good hedge against inflation. Oil and gas are components of the consumer price index. Also, the technology sector does well when the economy is improving. So you might consider entering into these sectors.


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