Safest assets provide no protection amid the brewing rate storm

Some of the most reliable corners in financial markets are reeling as interest-rate risks take hold.

From investment-grade credit to consumer staples, tried and true investing strategies are trailing the broader market as income-hungry traders feast on assets that offer yield, effectively for the first time since the crisis.

While U.S. stocks are trading close to a two-month high, the threat remains that rising rates will keep traders on the defensive. At the same time, those higher Treasury yields have dented returns in the very assets leery investors turn to in times of market stress.

“Bond proxy sectors are proving to be anything but defensive,” Andrew Lapthorne, global head of quantitative strategy at Societe Generale, wrote in a note Monday. “Little wonder global sector leadership is becoming increasingly narrow in 2018.”

Companies once sought after for their consistent payouts have been dethroned as higher returns on risk-free assets spur competition for capital. Longer-maturity corporate debt — which suffers more than lower-duration counterparts when rates climb — has sustained some of the worse losses since 2000.https://www.investmentnews.com/wp-content/uploads/assets/graphics src=”/wp-content/uploads2018/05/CI115678525.PNG”

Case in point: One of the worst-performing equity strategies this year is one investors had flocked to over the past decade, assuming it was low risk. That is, stocks with high dividend yields and low price volatility, according to equity strategists from Bank of America.

A PowerShares ETF established in 2012 that tracks the investing style posted stellar gains in recent years. This year, the fund has fallen about 4% while the S&P 500 is some 2% higher. The total return of an S&P 500 index of high-dividend paying stocks has slumped 1.2% in 2018, when including payouts.

“Market participants have been mispricing risk since the financial crisis, in our view, conflating safety with low price volatility and capital preservation with high dividend yields,” Bank of America equity strategists headed by Savita Subramanian wrote in a note this month. “These risks are just now being revealed.”

The consumer staples index — littered with defensive companies that make things like diapers and ready-to-eat foods — has fallen 13% this year. The sector is on track to post its biggest yearly loss since 2008.https://www.investmentnews.com/wp-content/uploads/assets/graphics src=”/wp-content/uploads2018/05/CI115677525.PNG”

Even as the U.S. economic expansion has become the second-longest on record, the path for interest rates is dominating investor mindsets.

U.S. high-yield bonds, which are acutely sensitive to a downturn in the credit cycle, have fallen 0.1% this year, compared to a whopping 3.9% decline for the investment-grade gauge, which has a longer modified duration.

Bond surrogates may see their dividend yields continue to shrink relative to the two-year rate as the Fed presses ahead with hikes. All this comes amid a market hypnotized by rich valuations, creating another headwind for bond-proxy stocks beyond interest rates.

With a price-to-earnings ratio above 20, the S&P high yield dividend index is susceptible to mean reversions. Investors hoping to avoid lofty valuations are “torn” on pricey defensive companies, according to Mr. Lapthorne.

(More: Loomis Sayles’ star bond manager talks about rising rates and trade wars)​