Higher yields are taking their toll on all areas of the stock market, except the one that matters

By Michael Kramer

Technology is the only one of the S&P 500's 11 sectors that gained since Sept. 1, as Treasury yields have climbed to multi-decade highs

Rising bond yields have been hurting every sector except the one that has been strong enough to lift the market indexes to record highs. Yes, that sector is technology.

The S&P 500 may have reached a record close this week, but that doesn't mean all is well in the stock market. In fact, rising interest rates are taking a toll across the market, and it's becoming clear that one sector alone is keeping things from unraveling.

That one sector, which should come as no surprise, is technology. Since Sept. 1, the State Street Technology Select Sector SPDR exchange-traded fund XLK has advanced 10% through Oct. 6, while the SPDR S&P 500 ETF Trust SPY has gained 2.3%. The next best performing sector was communication services XLC, which has tacked on 0.7%. Every other sector in the S&P 500 has declined.

Interest-rate-sensitive sectors lead the decline

The biggest declines have been in sectors tied to interest rates. With rates soaring, it is not surprising that the State Street Real Estate Select Sector SPDR ETF XLRE was down nearly 7% over that same period, followed by the Financial Select Sector ETF XLF, down nearly 6%, and the Materials Select Sector ETF XLB, down more than 4%. It isn't so much that the market doesn't care about higher interest rates, it's that technology stocks don't.

What stands out is how the index's bottom-performing sectors have closely tracked the rise in the 10-year Treasury yield BX:TMUBMUSD10Y, which reached multi-decade highs this week. The chart below shows the relationship between the real-estate, financial and materials sectors and an inverted chart of the 10-year Treasury yield. The broad relationship is clear.

Momentum-driven trading

Several of XLK's top 10 holdings have posted strong gains: AMD's stock (AMD) has rallied more than 40%, Intel shares (INTC) have climbed more than 26%, shares of Applied Materials (AMAT) have gained about 20%, and Micron's stock (MU) has advanced 12%.

Of course, shares of Nvidia (NVDA), the leader of the entire trade, has also done well, up about 10%. With much of the top 10 holdings in the XLK ETF these days being semiconductor companies, one can reasonably conclude that much of the reason it seems as if the stock market doesn't care about rising rates is that the market cares a lot more about the artificial-intelligence trade, which continues to keep the index afloat.

Rates overall have had a profound impact on markets, and the longer rates remain elevated, and the higher they go, the greater the impact is likely to become. The challenge will be recognizing which group or groups of stocks are creating the appearance of a stock market that doesn't care.

One thing we know from past experience is that the semiconductor and AI trade has been wobbly at times, and it has been very much a momentum-related trade - and that momentum has been known to shift from time to time. If that trade shifts, the index is likely to take notice, especially if rates don't come down and other sectors can't rally to offset weakness in the S&P 500.

This is another reason the Invesco S&P 500 Equal Weight ETF RSP has been down nearly 2.5% since Sept. 1, while SPY, which weights companies by market capitalization, has risen more than 2%. This divergence shows how sector rotations out of nearly everything and into technology have helped mask underlying weakness in the headline index.

Interest-rate-sensitive, capital-intensive business sectors are likely to keep feeling the pain of higher interest rates. For now, technology stocks have weathered the storm, but with the AI data-center build-out still under way and demand for capital still extremely elevated, even that sector may not be immune to rising costs of capital over the long term - it may just be a matter of when.

Michael Kramer is the founder of Mott Capital Management and a long-only investor focused on macroeconomic themes. He analyzes long-term macro trends and short-term market risk using technical analysis, fundamentals and options-market positioning. See here for further disclosures.

-Michael Kramer

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10-07-26 1658ET