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Homebuilders and Utilities: Holes in the Defensive Playbook

By:Jermal Chandler

With the 10-year treasury yield sitting near 16-year highs, defensive stocks are not looking like safe havens

  • The 10-year treasury yield is sitting near 16-year highs.
  • The homebuilder and utility sectors are suffering as a result of higher interest rates.
  • Traders are hoping the September jobs report shows a cooling labor market.

10-Year yield

Recently, interest rates have been on a tear. The 10-year treasury yield, which typically serves as a benchmark for mortgage rates, traded as high as 4.87%. That's the highest level since 2007—yes, the same year Steve Jobs introduced the iPhone, the Dow closed about 13,000 for the first time and the Colts beat theBears in the Super Bowl. Geez, a lot has changed since then.

Percentage change for SPY, XLU and 10Y

In fact, interest rates are moving so fast they are beginning to disrupt other areas of the market. Take a glance at the Utilities select sector SPDR fund (XLU). It's been rocked to the tune of -20% return year-to-date. Rising interest rates, in effect, mean borrowing costs will go higher. If you know anything about utility companies, you know many of them have high capital expenditures and large debt-to-market cap levels. Needless to say, this is not a favorable environment for them.

Percentage change for XHB & Homebuilders

However, utilities are not alone. As the Federal Reserve has waged war on inflation by raising rates, homebuilder stocks are beginning to feel the pain as mortgage rates lurch higher. Many stocks across the homebuilding sector, such as Lennar (LEN), PulteGroup (PHM) and D.R. Horton (DHI), have been in a downtrend since the Fed's last rate hike on July 26. It's simple. With the average U.S. mortgage nearing 8%, people are just not as excited to buy homes at the rate we saw just two years ago.

So, when will the safe investments like utilities and homebuilders rise again? What you should be asking is, "What's going to bring interest rates down?" Well, many market watchers are hoping the labor market will loosen up and give the Fed some breathing room to tone down its hawkish rhetoric and actions. On Wednesday morning, the ADP jobs data showed the U.S. added the fewest number of jobs in September since the start of 2021. That report from the human resources services giant suggests demand for labor in several industries is slowing down, which feeds into the theory that we don't need higher rates.

The problem is, ADP isn't exactly the most reliable predictor of the government's monthly jobs data. So, we still have to wait for the real thing on Friday—when the nonfarm payroll report, or NFP, is released. And if September's NFP report can show the labor market is cooling as well, then maybe traders won't worry so much about rates staying higher-for-longer. We shall see.

Jermal Chandler,tastylive head of options strategy, has been in the market and trading for 20 years. He hosts Engineering the Trade, airing Monday, Tuesday, Thursday and Friday. @jermalchandler 

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