Since last September, the yield on the U.S. 10-Year Treasury has steadily increased from 2.05%, eventually surpassing the important psychological level of 3%.1 While we've written recently about the implications of rising rates for fixed income investors, we believe it is important to understand the consequences this has for equity investors too.
Rising interest rate periods are often associated with a more positive view on economic growth. As a result, cyclical sectors—such as Consumer Discretionary, Industrials and Financials—tend to outperform during periods of rising interest rates. Similarly, falling interest rates are associated with a slowdown in economic growth. Defensive sectors—such as Consumer Staples, Utilities and Health Care—fare better when rates are falling.
Defining rising and falling interest rate periods by looking at trends in the moving averages for the U.S. 10-Year Treasury yield2 allows us to see how sectors typically behave during the different regimes. The table below shows how different sectors within the MSCI USA Index performed over the past 20 years. We can see that equities in general performed better when rates were rising. We can also see that defensive sectors outperformed during falling rate periods, while cyclicals outperformed when interest rates rose.
More than 11 years ago, WisdomTree pioneered fundamentally weighted indexes by launching its U.S. dividend- and earnings-weighted Index families. Once a year, WisdomTree's U.S. dividend-weighted Indexes will weight dividend payers by their aggregate share of indicated dividends to be paid. Likewise, the U.S. earnings-weighted Indexes are reconstituted annually, weighting companies with positive earnings by their proportionate share of total aggregate earnings. Companies with greater earnings generally have larger weights in the Index. Both dividend- and earnings-weighted families have a total market version along with large-, mid- and small-cap size cuts.
