Skip to main content

Rising Rates and Their Impact on "Safe Assets"

Jason Zweig of the Wall Street Journal wrote an article an interesting article observing in part what happened to certain asset classes investors typically deem safe during the rising interest rates of 1994. During this year the FED raised rates 5 times. He wrote:

"The biggest fear of investors then was that the Fed would tank the markets, which still were recovering from the recession of 1990-91. That didn't quite happen; the U.S. stock market overall earned 1.3% for the full year in 1994.

But the damage was widespread, hitting supposedly safe and risky assets alike. For the full year, utility stocks lost 15.3%; municipal bonds, 5.2%; emerging markets, 8.7%; intermediate-term Treasurys, 5.7%; the U.S. bond market as a whole, 2.9%; gold, 2.2%. REITs eked out a gain of 0.8%; without their generous dividend yield of roughly 7%, they would have lost 6.4%. (The average yield on REITs today is a bit over 3%.)"

Most investors don't think that their bond funds can lose money as they did in 1994. This was at a time when 10-year treasury bond yields were north of 5%. These interest payments provided much more of a cushion than today's paltry 2% comparative yields.

Investors may have noticed that May was unkind to bond funds. During the month, the 10-year treasury yield increased by about 0.5% and bond funds suffered -- recall bond prices move inversely from bond yields. The Barclays US Aggregate Bond Index lost -1.78% in May while Vanguard's Long-Term Bond Index Fund (VBLTX) lost -5.32%.

Further, most investors don't believe that their beloved high-dividend-paying stocks, which include utilities, could also suffer more so than the overall market. Zweig notes that the higher yielding asset classes -- utilities, REITs, high dividend paying stocks -- have done well but their valuations may have become overheated. The fact that they have become so increases the risk of a greater reversal.

The FED has publicly stated their intent on keeping interest rates low and has a long-run inflation target of 2%. So today isn't like 1994...yet.

Click here for the full article, The Japan Syndrome: Rising Rates and Risky Exposures.

Popular posts from this blog

Diversification: Disciplinarian of Disciplinarians

Disciplined diversification works when you do and even when you don't want it to. Diversification in effect forces you to sell the thing that has been doing so well in your portfolio and to buy the thing that hasn't. While this makes rational sense, it is emotionally difficult to execute. Think back to the tail end of 2008--were you selling bonds and cash to buy stocks? Most likely you weren't unless your advisor or some sort of automatic trigger did it for you. Carl Richards of www.behaviorgap.com provided a good reminder of how diversification works in a recent NY Times blog post. The diversification he discusses here is more so related to equity asset-class diversification but also touches on the three basic building blocks--equities, bonds, and cash. He doesn't discuss alternative asset classes -- an asset class that doesn't fit neatly into the three basic categories -- being used to further diversification, but that's a detailed topic for another day. ...

Did You Do as Well as Your Mutual Fund?

It's common practice to look at a fund's total return number for a snapshot of what performance to expect, but that won't give you the full picture. Morningstar studies have shown that investors' actual gains frequently pale in comparison to reported total return numbers. This phenomenon frequently plays out among funds that attract assets after streaks of hot performance, only to see some investors get skittish at the first signs of underperformance . After a moment's though, even a novice investor will realize that this behavior is just the opposite of the mantra -- buy low and sell high. This practice can be more broadly attributed to bad behavior and lack of a plan or philosophy when it comes to investing. Investors are human and humans are emotional. As much as the logician in me would like to believe my left brain is working to drive my decision making, logic comes in after emotions are experienced to provide context for how we are feeling and not the other ...

Healthcare Reform Explained

If you're like me, you find the 1000 page plus Heathcare Reform Act a bit confusing. This nine minute animated movie -- featuring the "YouToons" -- explains the problems with the current health care system, the changes that are happening now, and the big changes coming in 2014, produced by the Kaiser Family Foundation. Kevin Kroskey, CFP, MBA