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Equity Perspectives

While bond investors generally suffered losses during the mid-2013 increase in interest rates, many segments of the equity market posted gains. Here's a look at the best performers.

The sharp rise in interest rates in mid-2013—the yield on the 10-year Treasury note climbed 142 basis points (bps) between May 2 and September 5, according to Bloomberg—left many fixed-income investors reeling. In contrast, and since May, equity investors appear to have dodged the bullet from the increase in interest rates. A case in point is that while the Barclays U.S. Aggregate Bond Index (a broad measure of the U.S. fixed-income market) posted a loss of nearly 5% during the period, according to Barclays data, the S&P 500 Index returned more than 5%, based on compounded daily returns compiled by FactSet.

Broadly positive returns for stocks during periods of rising interest rates should come as no surprise. The overall equity market has a history of performing positively during periods of rising rates in contrast to high-quality bonds. In fact, the S&P 500 has had a correlation of -0.25 with government bonds (as represented by the Barclays U.S. Government Bond Index) over the last 10 years as of November 30, 2013, according to Morningstar.

One reason that stocks may perform well during periods when Treasury yields rise is that such periods tend to coincide with improvement in U.S. gross domestic product. Simply put, a stronger economy means a better outlook for the U.S. companies whose stocks comprise the major equity benchmarks.

But investors should not become too complacent about the degree of protection that stocks may actually provide. Different segments of the stock market have performed in significantly different ways during periods of rising interest rates. Price action in certain segments of the stock market can be more influenced by economic activity, while other areas are primarily affected by changes in interest rates.

That's especially true when looking at the 68 S&P 500 industries within the Global Industry Classification Standard (GICS), a standardized classification system for equities developed jointly by MSCI and Standard & Poor's. During 2013’s "summer of rising rates," equity returns varied drastically on an industry level. As Chart 1 shows, the top 12 performing industries in the S&P 500, as classified by GICS, returned an average of 17.95% during the May 2–September 5 period; the 12 worst-performing GICS industries in the equity benchmark declined an average of 7.77%, an even worse showing than the above-mentioned return of the proxy for the bond market, the Barclays U.S. Aggregate Bond Index.


 

Chart 1. How Did Industry Returns Fare During the "Summer of Rising Rates"?
Average returns and yields for the period May 2–September 5, 2013

Source: FactSet.
Past performance is no guarantee of future results.
The historical data are for illustrative purposes only, do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Performance during other time periods may be different or negative. Investors may experience different results. Due to market volatility, the market may not perform in a similar manner in the future. Please refer to "Important Information" regarding the economic indicator data in these charts and index information. 


Of course, returns for industries in the S&P 500 can vary over any given time period based on valuations and industry-specific events, but a closer look at performance for these groups over the period under discussion provides some interesting insights. Chart 2 shows a stark contrast between the individual returns of the top and bottom 12 GICS industries. The top 12 are focused in industries that typically thrive during periods of economic growth: automobile-related, technology, and consumer finance/banking. The 12 laggards are typically more interest-rate sensitive industries: real estate investment trusts (REITS), utilities, telecommunications, and consumer staples. The discrepancy in returns is striking: The best performing industry, auto components, returned 27.13% during the period May 2–September 5, 2013, while the worst performer, REITS, returned a dismal -14.07%.


 

Chart 2. More Economically Sensitive Industries Outperformed During 2013's Interest-Rate Rise
Average return of the 12 best- and worst-performing GICS industries in the S&P 500 Index, May 2–September 5, 2013

Source: FactSet.
The Global Industry Classification Standard, or GICS, is a standardized classification system for equities developed jointly by MSCI and Standard & Poor's.
Past performance is no guarantee of future results.
The historical data are for illustrative purposes only, do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Performance during other time periods may be different or negative. Investors may experience different results. Due to market volatility, the market may not perform in a similar manner in the future. Please refer to "Important Information" regarding the economic indicator data in these charts and index information. 


The lesson here may be that investors who participate in equity markets during periods of rising interest rates may do well to be selective. While past performance is no guarantee of future results, there appears historically to be a pattern of outperformance for certain industries over others during these times. When considering the industries that could potentially hold up well in these interest-rate environments, it may be important to keep a careful eye on individual company valuations.

Understanding valuation ranges is a crucial part of the active management process, according to Sean Aurigemma, Lord Abbett Portfolio Manager. He defines the approach as follows: "What are the returns that are implied by stock prices—and do we believe that? Is there a high degree of difficulty in achieving those expectations?" That's where the thorough, disciplined research provided by professional investment managers may prove helpful. 

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