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Stock market already feeling sting of higher rates

Traders work in the S&P 500 options pit at the Chicago Board Options Exchange
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Traders work in the S&P 500 options pit at the Chicago Board Options Exchange

The relatively sharp jump in interest rates since the beginning of May has taken a toll on the stock market, and analysts see more pain ahead.

While the broader stock market has moved higher in that period of time, select groups have been battered with every tick higher in yields. Among those most vulnerable to the sting of rising rates are stocks with bond-like characteristics, meaning companies that are valued on their yield—or the amount they payout in dividends relative to their share price.

These high-yielding dividend stocks typically fall into certain sectors, like utilities and telecommunication services. Electric and phone companies often pay out a much larger part of their earnings in the form of dividends. This helps some investors get a bigger portion of their returns from income than from the capital appreciation of the stock.

However, as interest rates begin to rise, the allure of these dividend payments starts to fade. Bonds may become relatively more attractive as interest rates start to rise.

Since May 1, 10-year Treasury notes have gone from yielding around 1.63 percent all the way up to the nearly 3 percent levels that we see today.

(Read more: Pro strategies as 10-year nears 3 percent)

During that span, the two worst performing sectors in the S&P 500 have been utilities and telecom services. Utilities are down 11 percent as a group and telecom services are down more than 10 percent. Some companies that have been hit harder than others in the rising rate environment include FirstEnergy (-21 percent) and CenturyLink (-13 percent).

Meanwhile, the S&P 500 as a whole has gained nearly 5 percent. Interest rate sensitive stocks like the utilities aren't the only casualties as rates have started to rise. Many consumer-related stocks have also taken a hit. A big concern for investors is whether or not higher interest rates could put a damper on consumer spending.

"We're already starting to see it in some of the consumer areas," said Andrew Burkly, who heads up institutional portfolio strategy at Oppenheimer Asset Management, when asked if rising rates hurt stocks.

He notes that there are more negative signs coming out of areas in retail, like department stores. Other retail-related names have also been underperformers, like Target (-10 percent), Coach (-9 percent) and Ralph Lauren (-7 percent).

Traders have been watching the 3 percent level on the 10-year note, an area that they believe may cause some trouble for the broader market. Some analysts expect the stock market to continue to see choppier trading as yields move higher.

"We think we're getting fairly close to where it's going to start to have a bit of an impact," said Burkly.

In addition, rising interest rates take their toll on home affordability. As yields on Treasury securities rise, they lead to increases in mortgage rates. Higher mortgage rates mean less buying power for home purchases. Shares of some of America's biggest home builders have also suffered, like DR Horton (-31 percent) and Pulte Group (-27 percent).

On the flip side, there have been some real positive standouts during that time, namely industrial stocks. They're the best performing sector in the S&P 500 since early May. Diversified manufacturer Dover ( 28 percent) and Lockheed Martin ( 24 percent) are helping to lead the way higher in that sector. Even some consumer discretionary names that aren't necessarily that retail focused are doing well, like Goodyear Tire & Rubber ( 71 percent).

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These shorter-term trends make sense when comparing them to stock market behavior in past periods of rising rates. S&P Capital IQ Chief Equity Strategist Sam Stovall looked at performance for the S&P 500 going all the way back to February of 1970. He then focused on those time periods when interest rates were rising and looked at which sectors stood out.

Just as now, the worst performing stocks during periods of rising interest rates are utilities, financials and telecom services. The best performing stocks when rates move higher tend to be technology, energy and materials. Those are the more cyclical, or economically sensitive companies. In other words, the ones that rise or fall more based on the health of the bigger-picture economy.

For investors, a big concern is whether or not interest rates continue on their path higher and if they do, can stocks continue to rise with them. If history holds true, then it might bode well for owning the stocks that bet on a growing economy.

(Read more: Art Cashin: Beware this market 'trip wire')

However, even in data going back to 1970, there hasn't been a time where markets have been as profoundly affected by Federal Reserve intervention to hold down interest rates. The amount of monetary stimulus being applied to the economy is unprecedented.

Could that be distorting the fundamental story of how stocks perform in a time of rising rates? The jury is still out, but if you believe rising rates are here to stay because of an improving economy, it may be worth looking at cyclical stocks. If you're still bearish, the drop in less economically sensitive, or defensive stocks, could be a buying opportunity.

—By CNBC's Dominic Chu. Follow him on Twitter @thedomino.

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Senior Commodities Correspondent and Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.