Markets

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

This much rotation is enough to make your head spin. 

At the beginning of the year, investors became nervous about any number of things -- from a cloudy outlook for the global economy to banks' exposure to energy company debt to Britain's future in the European Union. The result was an epic desire to park money in any type of defensive industries that pay a healthy dividend at the expense of sectors more reliant on the economic cycle:

Leaders at the Half
Telecom, utilities, consumer staples and real estate stocks vastly outperformed in the first six months
Source: Bloomberg

Since then, sentiment has done a U-turn as Brexit came and went without a macro disaster (so far -- fingers crossed!)  and the Federal Reserve began laying the groundwork for an interest-rate increase by the end of the year.   

Treasury yields have perked up, increasing the competition for utility, telecom, real estate and consumer staples companies with high dividend yields. Utilities in the S&P 500 fell for 11 consecutive days through Friday, the longest slump on record for the group. 

About-Face
Industries known for their high dividends have fallen in the second half of the year
Source: Bloomberg

Clearly, the stampede into relatively safe and high-yielding stocks at the beginning of the year was an overreaction to an overabundance of caution. 

The question now, however, is whether the rotation out of those sectors will also prove to be an overreaction soon, if not already. The obvious culprit for the abandonment of high-dividend stocks has been a surge in Treasury yields -- the 10-year rate jumped almost 40 basis points from its low in July to 1.74 percent last week.

Treasury Turn
The rate on the 10-year Treasury has jumped almost 40 basis points from its low in July
Source: Bloomberg

Yet the selloff in utilities, telecom, real estate and consumer staples has also caused a sharp rise in their dividend yields. The sectors each now pay come-hither yields of about 3.6 percent, 4.7 percent, 4 percent and 2.7 percent, respectively, which are all healthy multiples of the 10-year Treasury rate:

After the Rotation
Dividend yields for these sectors are from 1.5 to 2.8 times the 10-year Treasury yield.
Source: Bloomberg data

One way to explain the ratios is to infer that equity investors are nervous that Treasury yields have further to go on the upside, offering even stiffer competition to the high-dividend yielders. In addition, valuations for dividend stocks are still lofty, and there's no guarantee that dividends will continue to rise; they might even (gasp) be in line for some cuts, depending on the industry.  

Of course, it should probably make you nervous to think about equity investors predicting the future path for Treasury yields -- or even bond investors predicting the path, for that matter -- especially with so many of the market's meteorologists calling for an uptick in volatility. 

So don't be too surprised if the room starts spinning again. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net