For the past one month, Wall Street is reeling under severe volatility, resulting in stepped up demand for safe-haven sovereign bonds and the consequent free fall of Treasury Note yields. There seems to be no respite from trade conflicts, with a tariff war with Mexico likely this month and deterioration in ties with China.
Moreover, precipitous trade-related conflicts started taking a toll on both U.S. and global economies. Tepid manufacturing data, lower business spending and muted inflation may compel the Fed to cut interest rates this year. At this juncture, it will be prudent to invest in rate-sensitive stocks like utilities and REITs with a favorable Zacks Rank.
Free Fall of U.S. Treasury Yields
Yields on several U.S. government bonds are witnessing a free fall since May 23. On that day, yield on U.S. Treasury Notes of various maturity dates tumbled owing to stock market uncertainty and concerns about a prolonged trade war.
On Jun 3, yield on 10-year U.S. Treasury Note plunged to 2.062%, its lowest since September 2017 before settling at 2.134%. Notably, the yield on 10-year government bond hovered around 2.55% in the first week of May.
Meanwhile, yield on 3-month U.S. Treasury Bill and 1-year U.S. Treasury Note stayed at 2.349% and 2.134%, resulting in a negative spread or partial inversion of Treasury Yield curve. The yield on long-term 30-year U.S. Treasury Note also dropped to 2.557%.
The yield curve (which measures interest at any given point of time for bonds of same quality but different maturity dates) of government bonds are generally upward sloping, implying that a higher rate of interest is needed for individuals to hold longer maturity bonds. However, an inverted yield curve is generally characterized as market’s diminishing expectations about future economic growth.
In fact, several economists consider inversion between the 3-month and 10-year bond yields as a clear indication of an upcoming recession. However, a more powerful indicator is the yield inversion between 2-year and 10-year U.S. Treasury Notes. Yield on 2-year U.S. Treasury was closed at 1.887% yesterday, marking yield inversion with 3-month and 1-year government bonds.
Will Fed Reduce Interest Rate?
On May 1, the Fed reiterated after its FOMC meeting that it will keep benchmark interest rate unchanged at 2.25-2.5%. However, the market is rife with speculation that the central bank will cut lending rate at least once during September to December.
U.S. manufacturing is suffering due to lack of global demand. The ISM Manufacturing Index for May came in at 52.1, the lowest level since October 2016. Construction spending also remains flat in May with respect to April.
Lingering trade conflict between the United States and China has already dented investors’ confidence internationally. China’s official manufacturing PMI for May slipped to 49.4, from April’s reading of 50.1. PMI readings below 50 signal contraction in the Chinese manufacturing sector. Yields on 10-year Treasury bond in Germany, Switzerland and Japan are currently in negative territory. Moreover, yields on 10-year Treasury bonds declined to less than 1% in France, Spain and the U.K.
Additionally, U.S. core PCE inflation index – Fed’s favorite inflation gauge – increased 1.6% in April, well below the central bank’s target rate of 2%. Muted inflation, global economic slowdown and the likelihood of a reduction of U.S. economic growth may compel Fed to reduce interest rate.
Our Top Picks
Under these circumstances, rate-sensitive investments like utilities and REITs, which offer attractive dividends, will be prudent. We narrowed down our search to five such stocks each carrying a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
The chart below shows price performance of our five picks year to date.
Middlesex Water Co. MSEX owns and operates regulated water utility and wastewater systems. It operates in two segments, Regulated and Non-Regulated. The company has expected earnings growth of 10.7% for the current year. The Zacks Consensus Estimate for the current year has improved by 5.9% over the last 30 days. The stock has a dividend yield of 1.64%.
NorthWestern Corp. NWE provides electricity and natural gas to residential, commercial and industrial clients. It operates through Electric Operations and Natural Gas Operations segments. The company has expected earnings growth of 5% for the current year. The Zacks Consensus Estimate for the current year has improved by 5.3% over the last 30 days. The stock has a dividend yield of 3.27%.
The GEO Group Inc. GEO is the first fully integrated equity real estate investment trust specializing in the design, financing, development, and operation of correctional, detention, and community re-entry facilities worldwide. The company has expected earnings growth of 8.5% for the current year. The Zacks Consensus Estimate for the current year has improved by 14% over the last 30 days. The stock has a dividend yield of 8.88%.
PennyMac Mortgage Investment Trust PMT invests primarily in residential mortgage loans and mortgage-related assets in the United States. The company has expected earnings growth of 3.5% for the current year. The Zacks Consensus Estimate for the current year has improved by 14.4% over the last 30 days. The stock has a dividend yield of 9%.
NexPoint Residential Trust Inc. NXRT invests primarily in residential mortgage loans and mortgage-related assets in the United States. The company has expected earnings growth of 11.7% for the current year. The Zacks Consensus Estimate for the current year has improved by 1% over the last 30 days. The stock has a dividend yield of 2.75%.
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