Treasury yields reached a new two-year high today and are very close to breaching the 3% barrier for the first time since early 2011.We are of the opinion that rising (US) bond yields are a positive sign because it suggests more (US) economic optimism.

Cyclical stocks should benefit from this economic growth (higher yields). Cyclical stocks include anything that is economically-sensitive including autos, metals, papers, machinery, chemicals and transportation. Examples of cyclical stocks (part o the CYC index) are Fedex, Goodyear, HP, Citi, Caterpillar, etc. By contrast, consumer staple stocks (beverages, food, drugs, tobacco, and personal products) usually lag in this growth environment.

Stockcharts.com’s John Murphy explain the facts above (that higher yields are better for cyclicals) with a simple chart.

“The black line in the chart is a “ratio” of the MS Cyclicals Index (CYC)divided by the MS Consumers Index (CMR). The green area plots the 10-Year T-Note Yield (TNX). The CYC/CMR ratio turned up last summer (2012) along with bond yields. An even stronger ratio upturn took place starting in April of this year when bond yields turned up in more dramatic fashion. Since mid-April (as bond yields were rising), the cyclicals index has gained 13% versus a 2% gain for consumer stocks (the CYC doubled the 6.7% gain in the the S&P 500 during the same period). The stronger performance by the index of economically-sensitive stocks appears to support the idea that investors are interpreting the rise in bond yields as a sign of economic strength. Stocks usually do better than bonds in a rising rate environment. Stocks also usually do better when cyclical stocks are leading them higher. Like autos.”

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