Overlooked corner of stock market offers protection from bond-market volatility

Investors wary of rising bond yields and the return of inflation that has been lacking since the 2008 financial crisis may find protection in one corner of the stock-market: the utilities and consumer staples sectors.

Both are typically defensive sectors and make up a combined 9% of the S&P 500’s $33.27 trillion market cap, the lowest since the 2000 dotcom bubble.

“If macro boom consensus correct then yields up another 50-100bps = higher volatility = defensives good market hedge” in the first half of this year, wrote Michael Hartnett, chief investment strategist at Bank of America.

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In the second half of the year, defensives will prove to be a “good macro hedge as global PMI's & US consumer spending peak,” he added.

The 10-year Treasury yield has climbed 72 basis points this year, closing at a 13-month high of 1.63% on Friday.

The sharp rise in the benchmark yield has come amid investor concerns that the unprecedented amount of fiscal and monetary stimulus that has been unleashed to combat the economic slowdown caused by COVID-19 will bring back inflation.

Congress has already approved almost $5 trillion of COVID-19 relief, including the latest round of stimulus that will send $1,400 checks to the majority of Americans. In addition, the Federal Reserve cut interest rates to near zero and pledged to buy an unlimited amount of assets to support the economy.

President Biden is planning another recovery package that could address infrastructure, climate change and other promises that he made on the campaign trail.

Economists surveyed by FactSet expect U.S. gross domestic to grow 6.3% in the second quarter as the stimulus money makes its way through the economy. That after growing at an expected 4.4% pace during the first three months of the year.

The strong growth, and the potential for inflation that comes along with it, have Wall Street analysts forecasting a further rise in bond yields as the pace of the economic recovery slows down in the back half of the year.

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Deutsche Bank strategists led by Francis Yared forecast the 10-year yield will reach between 2% and 2.25% before yearend and says the market will likely price in a greater than 50% probability that the Federal Reserve will exit its low interest-rate regime before the 2022 midterm election.

Higher interest rates, however, typically spell trouble for the utilities and consumer staples sectors that offer higher dividends, allowing them to perform