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PortfolioCafe

Rising Rates…What Investors Should Do Now

August 19, 2013

int ratesJust as the Fed’s latest weekly accounting reveals that the Federal Reserve’s holding of publicly traded U.S. Treasury securities pushed above $2 Trillion dollars, the yield on the Ten-Year Treasury reached a new yearly high of 2.89% today.

Back on Dec. 31, 2008, before the Fed began its strategy of “Quantitative Easing,” the Fed owned only $475.9 billion in U.S. Treasury securities. Since then, the Fed’s holdings of U.S. government debt have more than quadrupled.

Perhaps the bond market forgot to read the report issued earlier this year where it was explained in a February 2013 Congressional Research Service report,, “Under QE,”  “the Fed attempts to lower long-term Treasury and MBS [mortgage-backed security] yields directly through purchases that drive down their yields”.

So despite the record amount of purchases, rates are rising…and bond prices are falling.

Interesting too are the comments contained within the following video from Blacrock’s fixed income CIO Rick Rieder, where he states “the volatility in fixed income could actually be higher than the equity market.  You’ve seen it over the last few months. You’ve seen it very quickly in the last few months.”

I have been exclaiming for over a year now that bonds offer a portfolio no value and that the risks associated with owning bonds is asymmetrical…the downside risks far exceed any return potential.

Back in early June, when TLT was trading at $113, I issued a Special Opportunity alert for members, in which I indicated the immediate potential for higher interest rates. ” TLT finished nears its lows last week at $113.16 and for all intensive purposes, there isn’t much chart support.  The $105 area was the level of the price breakout to the upside and there was above average volume at that price too…so that’s an important level.  Below that, I could see TLT eventually hitting $95-$98.”  I had also recommended purchasing TBF (ProFunds Short 20+ Treasury) which was then trading at $30.91

Fast forward.  TLT now trades at $102.47 and TBF is $33.56 (+8.57%).

If we look at the following chart, it seems we are well on pace to reach my price target of $95 which would put yields on the Ten-Year around 3.25%.

tlt

No surprise, the interest sensitive groups such as real-estate and utilities are under pressure as both industries benefit from low-interest rates.  The Point and Figure Bullish Percent chart shown below displays how Real Estate has been declining since June and is now one of the groups leading the market lower in “bear confirmed” status.

real estate

Utility investors should monitor the rising price channel which has defined the trend of utility stocks since the ’09 lows and as shown on the following chart.  At a minimum I would expect to see the XLU (Utility SPDR) reach the bottom of the channel before attempting to bounce.   A material break of this channel would be reason to lighten up exposure to the group.

xlu

Finally, I will present one last chart for everyone who presently wishes that the Fed would begin tapering.

fed-mkt corr

Understand that the S&P  500 is 91% correlated to the level of the Fed’s balance sheet.  And with the Fed owning one-third of the Treasury market among primary bond holders, such a change may be disruptive.

Be careful what you wish for!

Action to Take:  

Investors who are still holding on to bond funds are likely to continue to feel pain.  Reducing exposure to any type of bond fund that owns long maturity bonds will minimize some but not all of the price risk.  A better choice for a portion of ones income investments may be floating rate funds and ETFs such as FLOT.  Such funds invest in bonds whose coupons change with prevailing short-term interest rates and are thus less sensitive to rising rates.

Stock investors should limit exposure to interest sensitive groups such as REITS and utilities.  Bear in mind however that rising rates can put pressure on all stocks so be sure to have a defensive plan ready (hopefully you have already begun implementing it).

In summary, I believe rising interest rates will be very disruptive to the already fragile financial markets and that investors can expect increased turbulence ahead.

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