This article is a guest post by James Paulsen, Wells Capital Management.
Escalating fears of a double-dip recession have made "economically defensive stocks" the investment du jour. Although defensive stocks may make investors sleep better at night, they may also expose a portfolio to a risk not immediately obvious—the long-term Treasury bond!
Bond Yields & Economically Defensive Stock Performance
Exhibit 1 compares the 10-year Treasury bond yield (solid line) with the relative stock price performance of Morgan Stanley's Consumer Stock Price Index (a proxy index for economically
defensive stock investments whose current composition is listed in Table 1). The relative stock price performance of defensive stocks is shown on an "inverted scale," so when the dotted line rises (falls), it illustrates periods of underperformance (outperformance).
Exhibit 1
For the last three decades, there has been a close relationship between the 10-year Treasury bond yield and the relative stock price performance of defensive stocks. Indeed, the best defensive stock outperformances since the 1970s have occurred contemporaneously with the four major declines in the 10-year Treasury bond yield (i.e., mid-1984 to mid-1986, early-1989 to early-1993, early-2000 to early-2003, and mid-2007 to late-2008). By contrast, economically defensive stocks have at best been market performers and often have underperformed during periods when the 10-year Treasury yield has risen.
