While U.S. basketball fans have been in the midst of March Madness, there has been no shortage of activity in global markets. Uncertainty over the policies from the new U.S. Presidential administration, stagflation concerns and, particularly, tariffs have weighed on investor sentiment, with the S&P 500^® down 4% in Q1. While fans analyze various teams to pick their brackets, what indicators are available to equity investors when making sector weighting decisions? With all eyes on the 10-Year Treasury yield, the U.S. dollar and crude oil, understanding the evolving relationship of sectors to bonds, currencies and commodities may prove timely in an environment of heightened macro concerns. 

Though March Madness teams have been narrowed from the Elite Eight to the Final Four, we can begin our analysis by sampling 2 of the 11 GICS^® sectors—the traditionally defensive Utilities sector and the cyclical Consumer Discretionary sector. Consumer Discretionary is particularly germane to market participants as it contains the Automobiles industry group, an industry that may be especially pressured by the recent announcement of auto tariffs. We calculated the historical six-month correlations of the excess returns of the S&P 500 Utilities and S&P 500 Consumer Discretionary, up 5% and down 14% YTD, respectively, versus the S&P U.S. Treasury Bond Current 10-Year Index, S&P U.S. Dollar Futures Index, and S&P GSCI Crude Oil.

Consistent with its defensive nature, Exhibit 1 shows that Utilities has tended to exhibit a strong positive correlation with bonds historically, while rate-sensitive Consumer Discretionary has had a more complex relationship. Positive correlations can arise, for example, due to an increase in yields, which may lead to a decline in spending as borrowing costs increase for consumers. On the other hand, negative correlations can occur during market downturns like we’ve seen recently, when risk-averse investors might reduce their exposure to the sector and turn toward safe havens like Treasuries. Consumer Discretionary currently has a slight positive correlation with the S&P U.S. Treasury Bond Current 10-Year Index, which is up 4% YTD.

(Click on image to enlarge)

Turning to the impact of currency movements on these sectors, with the S&P U.S. Dollar Futures Index down 3% YTD, the relationship of the U.S. dollar versus Utilities and Consumer Discretionary has oscillated over time, with both recently displaying a slight negative correlation. A weaker dollar can arise as a consequence of lower interest rates, which can aid in reducing borrowing costs for these sectors. Multi-national companies within Consumer Discretionary may further benefit from the translation effect of a weaker currency. But as both sectors generate most of their revenues domestically, a stronger dollar may also benefit domestically oriented companies.

(Click on image to enlarge)

Consistent with their recent negative association with the dollar, Utilities and Consumer Discretionary also demonstrate a negative relationship with crude oil prices, as rising commodity prices can raise input costs for companies within these sectors. An additional headwind for Consumer Discretionary could be the potential reduction in disposable income from higher consumer costs. The S&P GSCI Crude Oil is up 3% YTD.

(Click on image to enlarge)

The historical fluctuation of sector performance versus Treasuries, the dollar and crude oil spans beyond these two sectors. Exhibit 4 displays the correlations of excess returns across S&P 500 sectors versus each of these macro factors, which in many cases have differed significantly from their long-term averages since 2001.

(Click on image to enlarge)

Just as sports fans put their knowledge of basketball teams to the test as they approach the end of March Madness, understanding the nuances of sector movements versus bonds, currencies and commodities may prove useful when navigating market turbulence as we approach the beginning of Q2.

More By This Author: