Search This Blog

Tuesday, July 9, 2013

No It's Not Really Different This Time

Interest rates of course have moved up sharply since May with the 10 year treasury yield going from a low of 1.59% to a high of 2.7% a massive short term move for the bond market.

Over the course of the move down to record low interest rates a trend that accelerated since 2008 investors have rushed to "alternative investments" in the "search for yield". It certainly proved to be a profitable strategy as rates were low. 101 tells us that the present value of any cashflow is calculated by discounting it as the risk free rate. A good proxy for that risk free rate for a long term cashflow would be the ten year treasury yield. So simply put the value of a future stream of payments is worth less as interest rates go down.

So just as a long term bond bought with a yield of 1.5% is worth much less than par when market rates are at 2.7%, so too for bond equivalents. And if the "new consensus" of interest rate forecasts is correct or even close to correct and rates move towards 4% over the next year or two, there is no reason to expect this not to continue. In any event one would argue that there is minimal likelihood for any return to the market lows in interest rates.

The impact of the higher interest rates can be seen in bonds and several "bond equivalents"

Here is a one year chart of  TLH the 7 -10 year treasury bond ETF

And here are the charts for some popular "bond alternative" ETFs

Reits :

Preferred Stock

Utility Stocks

Some may argue that there may be some great "values" among the REITS, Utility stocks, and Preferred stocks as the group has been sold off as a whole. I am skeptical to any arguments that is a "stock pickers" market. This is particularly the case when the basic math of these instruments' value in a rising rate environment is inescapable.

So despite the recent sharp declines in price even for those that still hold these positions perhaps it is time to say "thank you" for the nice performance of these asset classes in the falling rate environment and move on to safer places such as short duration bonds more appropriate in a rising interest rate environment.

No comments: