Strategy Chart of the Day

Interest rate defensives … still on the defensive

April 20, 2018

Nick Chamie, Chief Investment Officer, International Wealth Management, Scotia Wealth

  • We categorize the utilities, REITs, telecommunications, and consumer staples sectors as interest rate defensive given their tendency to outperform during weak performance periods for the overall equity market, which typically is accompanied by falling interest rates and bond yields. The corollary is that these same stocks tend to underperform the broader market in an environment of rising interest rates and bond yields. Our sector strategy since 2016 has been to recommend underweight exposure to interest rate defensive sectors driven by our bullish view on the global economy and equity market performance alongside a rising interest rate/bond yield environment.
  • Year-to-date through April 18, interest rate defensive sectors have underperformed across both Canadian and U.S. equity markets. The four worst-performing sectors (with the exception of REITs in Canada) have been the interest rate defensive sectors, with local currency total returns ranging from -3.0% to -9.4% in the U.S. and -6.7% to -8.7% in Canada.
  • We believe bond yields are headed higher over the remainder of the year amid above-trend global economic growth, falling unemployment rates, inflation rates creeping higher, central banks tightening monetary policy, and commodity prices reaching new multi-year highs. Expanding U.S. fiscal and trade deficits in coming years will add to upside pressure on U.S. Treasury security yields in the near-term, in our view. Thus, we expect interest rate defensive sectors to continue underperforming the broader equity market, and cyclical sectors in particular, during these late stages of the business cycle.