Relative Performance of Industry Groups and the Yield Curve

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Here’s an interesting graph, but it needs a bit of explanation.

It’s the relative strength of each S&P 500 industry group relative to the yield spread. The horizontal axis shows the difference between the three-month and 10-year Treasury yield. The far left of the graph shows an inverted yield curve of 1%. As the graphs moves to the far right, the yield curve steepens to 4%.

Two items to mention. First, I used data going back to 1989. Also, I wanted a clean logarithmic graph so I adjusted the starting relative strength number to three. That doesn’t change the scale of the results but I wanted to make that point clear.

If you don’t mind me patting myself on the back, I think this is a fascinating chart. For example, you can see that tech stocks (the green line) do well as the yield curve becomes steeper, however, they run out of breath at the very steepest part. Materials stocks (royal blue), on the other hand, do their best at the steepest part of the yield curve.

You can also see that Utilities [white] do the best when the yield curve flattens out. This is obviously due to their high dividend yields. What I find most surprising is that financial stocks seem to be of the least impacted by movements in the yield curve.

So what does it mean? In 2007, the yield curve started off negative. When the market broke in late February, the spread stood at -0.50. The spread has gradually gotten wider ever since, meaning we’ve moved from left to right. By May, the spread finally turned positive. There was a retrenchment over the summer before the spread shot to over 1.6 in August. The spread currently stands at about 0.9. Here's a look at the yield spread over the last three years:

Since September, the Fed has cut short-term rates by 1%. If the Fed keeps cutting rates, the spread could reach 2.0 next year. From the first graph, that bodes well for health care [purple] and staples [yellow]—and the 2008 Buy List.