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Rising Rates and Their Impact on "Safe Assets"

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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.

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