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Yields Head for Big Monthly Gain: ETFs to Win & Lose

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Treasury yields have been surging lately buoyed by renewed optimism over speedy economic recovery and the resultant inflationary pressure as the COVID-19 pandemic subsides. Notably, 10-year Treasury yields rose to one-year high at 1.37% and are up from 0.67% on Sep 23. In fact, the 10-year yields are on track for their largest monthly gain in three years, having gained 26 bps so far in February (read: 5 ETFs to Benefit From Treasury Yield Surge).

The massive money flowing into the economy coupled with hopes of more fiscal stimulus and more Treasury supply is expected to lift inflation and in turn is driving long-term yields higher. Additionally, a recent spike in commodity prices, especially oil and metals, as well as the wider reach of COVID-19 vaccinations has lifted inflation expectations. Further, the Fed has pledged to keep short-term interest rates near zero for a longer period and continued its bond buying, allowing inflation to move in an average range that could rise above its 2% target without triggering a rate hike.

The 10-year breakeven inflation rate, which measures the market's inflation expectations, was 2.14% and recently hit its highest level since 2014, according to Bloomberg data. The breakeven rate is the difference in yield between 10-year Treasuries and 10-year Treasury Inflation-Protected Securities, or TIPS.

Pros and Cons

A rising rate environment is highly beneficial for cyclical sectors like financial, technology, industrials, and consumer discretionary. In particular, banks are at the most advantageous position as they seek to borrow money at short-term rates and lend at long-term rates. If interest rates rise, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits. Also, insurance companies are able to earn higher returns on their investment portfolio of longer-duration bonds (read: Here's Why You Should Buy Bank ETFs Now).

Higher rates would attract more capital to the country from foreign investors, thereby boosting the U.S. dollar against the basket of other currencies. However, this would have a huge impact on commodity-linked investments, reflecting that a rising rate environment will hurt a number of segments. In particular, high dividend paying sectors such as utilities and real estate would be the worst hit given their higher sensitivity to rising interest rates. Additionally, securities in capital-intensive sectors like telecom would also be impacted by higher rates.

Further, higher rates would also result in tighter lending conditions and curtail consumer spending on a wide range of products like cars and houses. This will in turn lower profitability across various segments.

Given this, we have highlighted three ETFs that will benefit from higher yields and the ones, which will badly impacted.

ETFs to Win

SPDR S&P Regional Banking ETF (KRE - Free Report)

This is one of the largest and the most popular ETFs in the banking space with AUM of $3.5 billion and average daily volume of 7.5 million shares. The product follows the S&P Regional Banks Select Industry Index, charging investors 35 basis points a year in fees. Holding 128 securities in its basket, the fund is widely spread out across each security with an equal-weight approach of around 4%. The fund has gained about 13% in a month and carries a Zacks ETF Rank #2 (Buy) with a High risk outlook.

Invesco S&P SmallCap Consumer Discretionary ETF (PSCD - Free Report)

The fund targets the small-cap segment of the broad consumer discretionary space by tracking the S&P SmallCap 600 Capped Consumer Discretionary Index. It holds 91 securities in its basket with none making up for more than 4% share. Specialty retail takes the largest share at 30.1% while household durables, hotels, restaurants and leisure, textile, apparel & luxury goods, and auto components account for double-digit exposure each. The product has attracted $41.2 million in AUM and charges 29 bps in annual fees. It trades in average daily volume of 10,000 shares and is up about 6% in a month. PSCD has a Zacks ETF Rank #2 (Buy) with a High risk outlook (read: You Can't Help Falling in Love With These ETFs).

Invesco DB US Dollar Index Bullish Fund (UUP - Free Report)

UUP offers exposure to a dollar against a basket of six world currencies. This is done by tracking the Deutsche Bank Long US Dollar Index Futures Index Excess Return plus the interest income from the fund’s holdings of U.S. Treasury securities. In terms of holdings, UUP allocates nearly 57.6% in euro and 25.5% collectively in the Japanese yen and British pound. The fund has so far managed an asset base of $385.9 million and sees an average daily volume of around 995,000 shares. It charges 76 bps in annual fees and shed 0.4% in a month. The fund has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: U.S. Dollar Rising: ETF Winners & Losers).

ETFs to Lose

Utilities Select Sector SPDR (XLU - Free Report)

With AUM of $11.6 billion, this fund provides exposure to a small basket of 28 securities by tracking the Utilities Select Sector Index. It is primarily concentrated on the top firm with 17.6% share while other firms hold not more than 7.8% of the assets. Electric utilities takes the top spot in terms of sectors at 63.5%, closely followed by multi utilities (29.7%). The product charges 12 bps in annual fees and sees a massive volume of around 10.7 million shares on average. It has shed 6% in a month and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.

iShares U.S. Home Construction ETF (ITB - Free Report)

This fund provides exposure to U.S. companies that manufacture residential homes by tracking the Dow Jones U.S. Select Home Construction Index. With AUM of $2.2 billion, it holds a basket of 46 stocks with higher concentration on the top three firms and charges 42 bps in annual fees. The fund trades in heavy volume of around 2.8 million shares a day on average. It carries a Zack ETF Rank #3 with a High risk outlook and has lost 1.1% in a month (read: Will Housing ETFs Gain as US Homebuilder Confidence Rises?).

SPDR Gold Trust ETF (GLD - Free Report)

Gold will lose its sheen as higher interest rates would diminish the metal’s attractiveness and the product tracking this bullion like GLD will lose. The fund tracks the price of gold bullion measured in U.S. dollars, and is kept in London under the custody of HSBC Bank USA. It is the ultra-popular gold ETF with AUM of $64.3 billion and average daily volume of around 8.5 million shares a day. Expense ratio comes in at 0.40%. The fund is down 2.6% in a month and has a Zacks ETF Rank #3 with a Medium risk outlook (read: How to Profit From Plunging Gold Price With ETFs).

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