An Equity Elixir for Rising Rates

Pay enough attention to the most frequently cited reasons for recent weakness in equities and one keeps popping over and over again: Rising Treasury yields.

On Friday, March 5, yields on 10-year U.S. Treasuries peaked above 1.62% and were residing around 1.556% in late trading. For those keeping score at home, that means yields on the benchmark U.S. government bond more than doubled over the past six months.

Market participants fretting over soaring Treasury yields is easy to understand. Rising bond yields mean prices are declining. Prices on any security don't move up in a straight line, but it's potentially ominous when investors lose their taste for the safest sovereign debt in the world.

Not to mention increasing U.S. government bond yields can be harbingers of rising long-term rates, meaning companies could eventually contend with higher borrowing costs.

Translation: It's certainly getting tiring hearing about Treasury yields being the impetus for market declines, but the reason is plausible nonetheless.

Remaining Engaged with Equities

As noted above, 10-year yields more than doubled over the past six months. The S&P 500 is higher by almost 7% over the same span. That's not a dismal performance by any stretch, but should government bond yields continue scooting higher, investors may want to consider the ProShares Equities for Rising Rates ETF (EQRR).

EQRR “seeks investment results, before fees and expenses, that track the performance of the Nasdaq U.S. Large Cap Equities for Rising Rates Index. The goal of the fund is to provide relative outperformance, as compared to traditional U.S. large-cap indexes, such as the S&P 500, during periods of rising U.S. Treasury interest rates,” according to ProShares.

EQRR's methodology is easy for everyday investors to understand. Historically, there are sectors that are positively correlated to rising rates and those that are hampered by that scenario. The ProShares exchange traded fund allocates 30% of its weight to the sector with the most positive correlation to rising 10-year yields over the past three years, 25% to the number two group on that basis, 20% to the third and so on.

These days, the result is a nearly 64% combined weight to the financial services and energy sectors, which just happen to be two of this year's best-performing sectors.

Conversely, EQRR features no exposure to capital-intensive sectors such as real estate and utilities. Nor does the fund have any allocations to either of the two consumer sectors.

More EQRR Perks

When looking at EQRR's name, it's obvious the fund is designed to thrive when rates rise and it's living up to that billing amid the aforementioned 10-year yield spike.

However, that doesn't mean that the case for this ETF evaporates if Treasury yields drift lower. Obviously, rising rates are helping EQRR, but so is renewed affinity for cyclical value stocks – something the ETF is chock full.

Looking at the financial services and energy sectors, both have upside catalysts that aren't directly tied to rates. As the economy improves, banks will be able to repatriate loan loss reserves back into profits and the Federal Reserve could sign off on buybacks and dividend growth later this year.

With that economic improvement should come the highly anticipated unleashing of pent up demand for Americans to travel again – be it by airplane, automobile or cruise ship. The energy sector is already pricing that with previously moribund names in the group recently hitting 52-week highs.

Bottom line: EQRR is worth a look today, but its utility extends beyond the near-term.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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