Equity View: Unwind Underweights in Homebuilders and Russell 2000 

Summary 

• We suggest investors unwind underweights in homebuilders and Russell 2000, via ETFs XHB and IWM. 
• We went to underweight on concerns that these rate-sensitive sectors would underperform if, as we expected, rates rose. 

• After a 60bp runup in the 10Y Treasury yield, we think the rate selloff run its course for now. 
• The primary reason to retain these underweight positions is expectations that higher rates will push the economy into recession in coming months. 
• Today, we see little risk of a recession any time soon. 

Unwind Tactical Underweights 

In mid-August, we became concerned about the prospect of rising rates at the longer end of the yield curve. We suggested investors underweight homebuilders via the ETF XHB. A month ago, we also suggested underweighting the Russell 2000 via the ETF IWM.  

These sectors have been interest rate sensitive historically and this year. Given that economic fundamentals remain sound, we viewed these trades as tactical, intended to run while rates were rising. 

Since the initial XHB call, the 10-year Treasury yield has soared 60bp to near 4.8% (Chart 1). 

Equities have come under pressure. 

Over the term of both trades, the S&P 500 is down about 5%; XHB is down 8.8%, and IWM is down 9.3% from when we suggested each trade. 

We suggest investors unwind these trades. We think the rate selloff has run its course for now, and these ETFs will settle into a new trading range – or recover somewhat if Treasury yield drop modestly.  

The primary reason to continue an underweight position is if one expects the higher rate regime to push the economy into recession in coming months. Today, we see little risk of a recession any time soon. 

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)