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I’ve been warning about the risks of rising interest rates for a long time — as far back as 2012, in fact. If you heeded my warnings, you avoided the worst year of losses for bonds, bond mutual funds, and bond ETFs since 2009, and before that, the late 1990s.
But what about stocks? They did very well last year. Then earlier this week, the Standard & Poor’s 500 Index hit 1,873, its highest level ever. How can that be? Aren’t surging rates bad for equities?
My answer: It depends.
No, that’s not a cop out. It’s the honest to goodness truth — a view I’ve developed after studying a half-century of interest rate history, and trading and investing my way through the last decade and a half of shifting rates.
Take last year. Sure, the S&P 500 was up by around 30 percent. But did you know the average real estate investment trust (REIT) was basically unchanged? Or that utilities underperformed the S&P dramatically, with a gain of less than 13 percent?
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| In the midst of surging interest rates, the S&P 500 Index hit its highest level ever this week. |
If you were loaded up with those kinds of “bond alternative” names, you were probably pretty disappointed in your portfolio’s performance. And that goes to show that in the early stages of an interest rate rise, rising rates are bad for those kinds of rate-sensitive names.
It’s why I recommended Safe Money Report readers bag nice, double-digit profits on their utilities in early 2013 — before they got slammed. It’s also why I stayed the heck away from REITs. More recently, it’s why I’ve been warning against some of the emerging markets that are vulnerable to rising rates and the capital flight it can induce abroad.
But at the same time I was warning our members to avoid all long-term bonds and those bond equivalent names, I was recommending several other fundamentally strong stocks, with solid Weiss Ratings, in sectors with little rate sensitivity and powerful bull trends. Many of those stocks are now paying off handsomely, with solid single-digit and double-digit gains — as much as 66.5 percent, in fact.
Why? Because interest rates haven’t yet violated my all-important “Three ‘F’ Rule:” They haven’t risen far enough, fast enough, and for long enough to slam the broader market.
You see, in the early phase of an interest rate increase, stocks overall don’t have to get slammed. One reason rates are rising is that the broad economy is growing, and that’s positive for corporate earnings. There are even some select financial and other stocks that can benefit from rising rates in this stage of the cycle.
But eventually, rates reach a tipping point. They start moving in huge chunks, in short periods of time. They breach key levels many investors could only have dreamed of early in the cycle. That is when you have to get the heck out of Dodge, because the entire stock market tends to get crushed.
We saw that happen in the 2003-2006 cycle, when rates eventually rose high enough to crush the housing and mortgage markets, as well as the overall economy. We saw that happen in 1999-2000, when rates eventually increased enough to prick the tech bubble and send the economy into recession. And we saw that in the 1993-1995 cycle, when rates rose far enough and fast enough to bankrupt Orange County, California, and to pull the rug out from under banking and financial stocks.
How can you know when that tipping point is nearing? Well, for starters make sure you subscribe to Safe Money. We’ve been successfully navigating this interest rate cycle for more than a year. My mentor, Martin Weiss, and I together have more than 40 years of experience navigating changing rates. Just click here for details on how to get signed up.
Second, keep your eye on key levels for key rates. The yield on the 10-year surged from around 1.6 percent last spring to 3 percent at the turn of the year. It recently corrected down to 2.6 percent, but the next leg up likely is coming very soon. I think we’ll blast through 3 percent before long … on our way to 4 percent or 4.5 percent over the next several months.
That’s when I will likely start to get more cautious, because rates above 4 percent probably will start to bite in many sectors. But until then, I believe you can still generate decent profits by focusing on the kinds of high-quality, low-rate-sensitivity stocks in the sectors I’ve been highlighting.
Until next time,
Mike
Mike Larson graduated from Boston University with a B.S. degree in Journalism and a B.A. degree in English in 1998, and went to work for Bankrate.com. There, he learned the mortgage and interest rates markets inside and out. Mike then joined Weiss Research in 2001. He is the editor of Safe Money Report. He is often quoted by the Washington Post, Reuters, Dow Jones Newswires, Orlando Sentinel, Palm Beach Post and Sun-Sentinel, and he has appeared on CNN, Bloomberg Television and CNBC.
