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. ...

65-80 Year Olds … A New and Exciting Demography

Should today’s 70-year-old American be considered “old?” How do you define that term these days? Statistically, your average 70-year-old has just a 2% chance of dying within a year. The estimated upper limits of average life expectancy is now 97, and a rapidly growing number of 70-year-olds will live past age 100. Perhaps more importantly, today’s 70-year-olds are in much better shape than their grandparents were at the same age. In most developed countries, healthy life expectancy from age 50 is growing faster than life expectancy itself, suggesting that the period of diminished vigor and ill health towards the end of life is being compressed. A recent series of articles in the Economist magazine suggest that we need a new term for people age 65 to 80, who are generally healthy and hearty, capable of knowledge-based work on an equal footing with 25-year-olds, and who are increasingly being shunted out of the workforce as if they were invalids or, well, “old.” Indeed, the a...

Should We Go Back on the Gold Standard?

If you watched the Republican presidential debates, you might have noticed that a number of  candidates yearn for a return to the gold standard—that is, that every dollar issued by the government would be backed by a comparable value in gold bars that were stashed away in a government vault. Sen. Ted Cruz of Texas argued that the dollar should have a fixed value in gold, and Sen. Rand Paul of Kentucky added that printing money without backing in the precious metal destroys the value of our currency. Mike Huckabee, former governor of Arkansas, thinks that if not gold, then the dollar could be pegged to a basket of commodities. All are mostly concerned that printing money will cause runaway inflation.   But there may be several problems with this return to the fiscal system of the late 1800s and early 1900s. One is that inflation has barely budged even as the Federal Reserve Board was piling one QE stimulus on top of another, and the government was adding records amoun...