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Which Four Sectors Need Higher Interest Rates?


Negative real interest rates have run their course.

MINYANVILLE ORIGINAL One of the reasons pharmaceuticals are so expensive to develop is the rigorous and almost obsessive-compulsive testing that firms such as Merck (MRK) and Pfizer (PFE) must to do before getting FDA approval. Even after approval, testing continues in ongoing research studies, especially the double-blind where neither doctor nor patient knows who has taken the placebo.

It would be nice if central banks were held to similar standards. But they are not, and therefore they are allowed to hold onto such untested notions as low interest rates stimulate economic activity. What they really do is reward Wall Street and create an illusion of prosperity.

Well, here we are, after four and one-half years of a zero interest rate policy (ZIRP), after two rounds of money-printing, after extensive twisting. These policies have been so successful that the US record-low 10-year Treasury yields look Brobdingnagian in comparison to their German bunds counterparts.

The US has negative real interest rates out to 2027; the UK out to 2062, and even little Denmark has negative nominal yields out to three years; how rotten is that?

Industry Group Impact
If we look at the partial contribution of 10-year Treasury yields to US industry groups, we see the net beta-weighted measure is negative: Lower yields are a positive for the market, all else held equal. However, that is deceptive as it masks a very pronounced sectoral skew. Industry groups with a negative partial contribution from higher yields are concentrated in the defensive sectors of health care, consumer staples, and utilities (XLV, XLP and XLU sector ETFs). Lower yields will help these groups, but these sectors seldom provide strong market leadership.

Click to enlarge

Now take a look at what is on the right-hand side of the table.

These industry groups are concentrated in the basic materials, industrials, financial and energy sectors. Those are groups capable of providing market leadership.

If the Federal Reserve has been trying to create inflation as a way to repudiate the federal debt, it might have boosted the energy and basic materials sectors (sector ETFs XLE and XLB). Or if lower interest rates boosted financials (sector ETF XLF) via the carry mechanism, they would have done so by now.

So, was the ZIRP, twisting, and money printing the medicine after all? Or the placebo?
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