Interest Rate Products – Not just for passive investors anymore
Okay everyone…listen up…I’m calling it: we’ve hit the bottom in interest rates administered by the Federal Reserve and Bank of Canada. Breaking news, I know! Rates have held at significantly low levels for months now and investors are anxiously anticipating the “hike†to surely come. The Bank of Canada already is hinting about the possibility of an administered rate hike as early as June. The Federal Reserve is hinting about the possibility of a Fed Fund rate hike in the second half of 2010. Should you stay invested in equities or transition to fixed income products?
Anticipation of a pending increase already has impacted bond yields and lending rates. The higher cost to borrow for investment purposes already is eating away at the decimated sum of money you call your portfolio. T-Bill yields have begun to rebound from lows not witnessed since the 1950’s. Yields on 10 year U.S. Treasuries recently pushed through 4.00 percent. Expectations are that yields on long term U.S. Treasuries will remain between 4.00 percent and 4.75 percent for an extended period of time.
Successful equity investors, who entered equity markets a year ago, are concerned that a rate increase by the Federal Reserve will dampen economic recovery and will trigger a stock market retreat. These are investors who are sitting pretty with gains of over 100% since the market bottom a year ago. They have become known on Bay Street and Wall Street as “the Bubble Boysâ€
Let’s examine the impact on U.S. equity markets before and after Fed Fund rate increases during the past 55 years. The period prior to the event averaged gains by the Dow Jones Industrial Average of 0.41 percent, 0.99 percent and 1.94 percent over 30, 60 and 90 days, respectively. Investors juiced what they could from lenders to put money to work at relatively low rates. After a Fed Fund rate increase, the Dow Jones Industrial Average recorded an average decline of 0.8% over the next 30 days followed by declines during the next 60 and 90 days surpassing 1.25 percent. Out of the 70 periods after a Fed Fund rate increase, only 25 recorded positive equity market returns after 30 days.
History provides the proof: Administered rate increases bring equity market rallies to an end. So party while you can, equity investors! The top for equity markets is about to be revealed.
What can investors do? Investors will need to shift mentalities. Quick gains from a recovery in deflated equity values no longer are available. Equity markets are entering a period of stock picking. I hope you’ve remembered your Investment Advisor’s telephone number after throwing it out the window after the crash of 2008.
Negative tendencies after rate hikes impact commodity prices as well. Gold and oil recorded losses of 4.38 percent and 1.49 percent, respectively, in the 30 days following the move. Equities are out, along with commodities!
So, where can the “bubble boys†hide? Coincidentally, the period of seasonal strength for Fixed Income products is approaching. Seasonal studies show that yields on long term Treasuries peak and Treasury prices bottom at the beginning of May. The seasonal trade for long term U.S. bonds is lining up nicely this year. Yields on long term Treasuries have trended upwards during the past month and a half. Treasury prices are set for their traditional annual low period followed by seasonal strength from May to December. As investors take notice, they will begin to shift from equity investments into fixed income investments.
Investment gains don’t have to cease. Equities have now reached highs not witnessed since the pre-recession period. A central bank administered interest rate increase may be the catalyst that brings to an end the period of dramatic short-term gains in equity markets. T-Bills and Bonds will become the investment vehicle of choice as the second half of 2010 approaches.
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