Longer term interest rates have been marching steadily higher for the past several months. Income investors are under pressure.
Is this a sea change or just a bump in the road?
It’s a supremely important question for investors.
The financial media loves to talk endlessly about the US Federal Reserve, aka the Fed, and their focus on short-term interest rates.
When will they raise rates? How much will they raise? Will they ultimately have to lower rates and have a negative interest rate policy similar to what’s happening in much of Europe?
I can’t blame them.
When you’ve got to sell advertising, you need something to talk about every day. For us as investors, however, it’s longer-term interest rates that we should really be paying attention to … and longer term yields are on the move.
Look at what’s happened to the yield of the 10-year Treasury Note. In early July, the yield was below 1.40%. Since then, the yield has risen to almost 1.80%. That’s an increase of nearly 30%!
The 1.40% level was last seen almost 4 years ago in the summer of 2012 and the longer-term trend is still lower, but it won’t take much to break the downtrend. A move above 2.00% could signal a move even higher.
What does this mean to individual investors?
For those who focus on generating income from their stock investments, this has not been a good couple of months.
Already we’ve seen interest rate sensitive groups like utilities and REITs affected by this push higher in the longer-term rates. The utility sector, for example, pierced into the SSI Yellow Zone and almost stopped out … but it hasn’t yet.
The chart of the REITs (real estate investment trusts) looks almost exactly the same. It came close to touching the red SSI Stop Loss (it even did touch it intraday) before recently moving higher.
One interest rate sensitive investment group that has not suffered the same kinds of recent declines is inflation protected Treasuries, aka TIPS. For most bonds, rising yields mean falling prices. Not necessarily with TIPS.
The principal in a TIPS bond increases if inflation, as tracked by the Consumer Price Index or CPI, is increasing. You can see in the following SSI chart on TIP, the iShares ETF that tracks a basket of TIPS, how the price of TIP rose steadily through the first half of 2016 along with all longer term US Treasuries.
What you also see in the chart above, however, is how TIP prices have NOT fallen off as longer-term yields have risen since July. That’s because TIPS are inflation protected… and inflation has recently been on the rise per the CPI.
Let’s conclude this review of the impact of recently rising long-term yields on interest rate sensitive investments by taking a look at the big picture.
The following chart shows that yields on T-Notes have been in a 35-year downtrend since 1981. It’s far and away the single biggest trend in investing today.
When this trend finally changes … it will represent a sea-change for all investors … and for the global economy. Every investor needs to be paying attention to changes in long-term yields – whether you’re an income investor or not.
Is this sea-change upon us today? Not yet … but the winds of change are stirring.
I’ll be keeping a close eye on this developing situation and will have more to say in the coming weeks and months.
Have a great weekend,