Commentary: Three strategies to benefit from higher rates
By Michael Larson, Money & Markets
Last Update: 1:37 PM ET Jun 13, 2007
JUPITER, Fla. (M&M) -- Don't look now -- but a sleeping market giant is
waking up and wreaking havoc. I'm talking about the Treasury bond market.
After going nowhere for months, Treasury prices have started falling
sharply. The long bond had its worst day in 26 months last week, then
plunged even further Tuesday. Since interest rates move in the opposite
direction of prices, they've been shooting higher. The benchmark 10-year
Treasury Note now yields around 5.25%, up sharply from a low of 4.43% in
December and the highest in five years.
What's driving the sell-off
The sharp housing market slowdown hasn't caused overall layoffs to surge
or the U.S. economy to slip into recession. Meanwhile, inflation still
remains above the Federal Reserve Board's comfort zone. So traders are
throwing in the towel on their long-held belief that the Fed will cut rates.
Foreign economies are growing like wildfire, prompting foreign central
banks to hike their rates. The European Central Bank just raised short-term
rates to a six-year high of 4%, while the Reserve Bank of New Zealand pushed
rates up to a record 8%.
Traders are worried foreign central banks will start diversifying out of
U.S. Treasuries and into other assets. China alone has more than $1.2
trillion in reserves, and it recently announced plans to diversify the make
up of that mammoth money hoard.
This is serious stuff for investors.
For one thing, rising interest rates provide more competition for stocks. If
you're a fund manager and you can earn more than 5.25%, risk free, on a
10-year Treasury Note, you might be less inclined to load up on high-risk
stocks.
For another thing, rising rates drive up financing costs for businesses --
and more importantly, buyout firms. We've seen a massive wave of private
equity takeovers in recent months. If rates rise sharply enough, those deals
will get prohibitively expensive, knocking one of the market's supports out
from under it.
My advice?
First, avoid interest-sensitive sectors of the stock market like housing,
commercial REITs, and utilities. REITS especially look overvalued, overloved,
and overowned to me -- and their dividend yields are near historic lows.
Sell.
Second, keep your fixed-income money in short-term investments -- things
like three-month or six-month Treasury bills and money market funds. You can
also look into low-cost, short-term, fixed-income exchange-traded funds,
like the iShares Lehman Short Treasury Bond Fund (SHV
The leveraged ETF is
designed to rise 2% for every 1% decline in the Dow Jones U.S. Real Estate
Index, a benchmark index of commercial REITs.
Two things to bear in mind: First, these are more aggressive investment
strategies that aren't for everyone. Second, we've already come a long way
in a short amount of time, interest rate wise. I wouldn't be surprised to
see rates take a breather to consolidate this move, or even correct lower
for a while, before resuming the uptrend. But ultimately, it looks to me
like we're headed to 5.5% -- and maybe as high as 5.75% -- on the 10-year
note.
Mike Larson is an analyst and editor at Weiss Research. He specializes in
housing markets, mortgages and interest rates and writes for a number of
Weiss publications, including Money and Markets.
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