A selloff in treasuries extended into the second day on Oct 3 after investors’ appetite for riskier assets improved following stronger domestic economic data and reports on easing fears of a clash over finances between the EU and Italy.
As treasury prices fell sharply, the 10-year Treasury note hit a multi-year high. Financials rallied on expectations to benefit from a rise in benchmark bond yield. At the same time, this rise in yield bolstered prospects of further rate hikes, leading to a stronger U.S. dollar. Small caps with domestic focus, in the meantime, are better poised to weather a stronger dollar. This category of stocks is cushioned against the loss of competitiveness and currency translation impact of a stronger greenback.
Bond Yields Hit Multi-Year High
The 10-year Treasury yield, used as a reference for everything from mortgages to student debt, rose 10.3 basis points to 3.159% on Oct 3, the highest since July 2011. This also marked its largest one-day climb since March 2017.
The 10-year note yield had crossed the coveted 3% mark on Sep 18, the first time since late May. The benchmark bond yield had exceeded the mark briefly in 2013 and January 2014, which was toward the end of the bond market wipeout, better known as the “taper tantrum.”
The 30-year bond yield, in the meantime, climbed 10.9 basis points to 3.315%, the highest since September 2014. The long-dated maturity also booked its biggest one-day rise since the day after President Trump’s election in November 2016. By the way, the shorter 2-year note yield too was up 4.5 basis points to 2.860%.
What’s Acting in Favor of Bond Yields?
Bond yields are rising as bond prices decline. The bond market is becoming less attractive as investors continue to load up on riskier assets due to a raft of stronger-than-expected economic data and ebbing concerns about the fiscal situation in Italy.
Private sector payrolls surged in September, as employers added 230,000 jobs, per Automatic Data Processing, Inc. (ADP - Free Report) . This, in fact, is the highest hiring rate since February and the first of the three reports on the labor market that will be released this week.
Another key barometer of the U.S. economy hits post-recession high. The ISM services index climbed to 61.6% in September from 58.5% in August, its second highest reading whose root dates back to 1997. Notably, all 17 industries tracked by the index, including finance, healthcare and retail, registered growth last month. The latest ISM data, thus, reassures that there is less likelihood of a slowdown any time soon.
Wall Street also got a lift after a report in Italian daily newspaper Corriere della Sera said that the government has found a solution in a budget standoff with the EU and this could eventually lead to lesser conflict between Italy and the bloc. Italian officials have earlier clashed with Brussels over budget deficit target that had exceeded EU regulations.
Financials Gain From Rise in Bond Yields
The yield on the 10-year Treasury note, especially, is a benchmark for interest rates. Thus, rise in such yields can boost bank profits as they increase the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities. The spread between long-term and short-term rates also expands during interest rate hikes because long-term rates tend to rise faster than short-term rates (read more: 5 Bank Stocks That Made the Most Since Lehman's Collapse).
Insurers, by the way, derive their investment income from investing premiums, which are received from policyholders in corporate and government bonds. Yields and coupons on these bonds rise in response to a rise in interest rates. This enables life insurers to invest their premiums at higher yields and earn more investment income, expanding their profit margins.
An increase in rates generally concurs during periods of economic strength and upbeat investor sentiments, which also bodes well for brokerage firms and asset managers.
Rate Hike Prospects Buoy Dollar
Rising bond yields indicate that the Fed, under its hawkish Chairman Jerome Powell, is likely to keep hiking rates from the current 2.25% well into 2019. Money market traders project more than two rate increases in 2019.
Prospects of a rise in federal funds rate resulted in a stronger U.S. dollar. The ICE U.S. Dollar Index, which measures dollar’s strength against a basket of major currencies, continues to trade near its highest level since August. The greenback continued to rise as currency traders tend to be drawn toward such currencies with attractive interest rates.
Small caps, in turn, are gaining as their wider domestic revenue exposure insulates them from the effects of a stronger dollar.
5 Solid Picks
Given the aforesaid positives, we have selected five such stocks that are poised to gain from rise in bond yields. These stocks boast a Zacks Rank #1 (Strong Buy) or 2 (Buy).
First Bancorp (FBNC - Free Report) operates as the bank holding company for First Bank that provides banking products and services for individuals and small to medium-sized businesses, primarily in North Carolina and northeastern South Carolina. The company currently has a Zacks Rank 2. In the last 60 days, two earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 1.3% in the same period. The company’s expected earnings growth rate for the current year is 63.2% compared with the Banks - Southeast industry’s estimated rise of 31.4%.
Berkshire Hathaway Inc. (BRK.B - Free Report) provides property and casualty insurance and reinsurance. The company currently has a Zacks Rank 2. In the last 60 days, three earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 12.5% in the same period. The company’s expected earnings growth rate for the current year is 68.9% compared with the Insurance - Property and Casualty industry’s estimated rally of 24.4% (read more: 4 Best Warren Buffett Stocks to Buy for Q4).
Banner Corporation (BANR - Free Report) operates as the bank holding company for Banner Bank and Islanders Bank, which provides commercial banking and financial products and services to individuals, businesses, and public sector entities primarily in the United States. The company currently has a Zacks Rank 2. In the last 60 days, two earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 1.6% in the same period. The company’s expected earnings growth rate for the current year is 25.8% compared with the Financial - Savings and Loan industry’s projected rise of 21.2%. You can see the complete list of today’s Zacks #1 Rank stocks here.
SEI Investments Co. (SEIC - Free Report) is a publicly owned asset management holding company based in Oaks, Pennsylvania. The company currently has a Zacks Rank 2. In the last 60 days, two earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings moved up 0.9% in the same period. The company’s expected earnings growth rate for the current year is 36.2% compared with the Financial - Investment Management industry’s estimated rise of 4.8%.
Vertex Energy, Inc. (VTNR - Free Report) , an environmental services company, provides a range of services designed to aggregate, process, and recycle industrial and commercial waste systems in 15 states, primarily in the Gulf Coast, Midwest, and Mid-Atlantic regions of the United States. The company currently has a Zacks Rank 1. In the last 60 days, one earnings estimate moved up, while none moved down for the current year. The Zacks Consensus Estimate for earnings rose 18% in the same period. The company’s expected earnings growth rate for the current quarter is 66.7% compared with the Pollution Control industry’s projected rally of 25.9%.
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