Interest Rate Rise Hurts Bonds Bad in 2Q

The U.S. stock market ended the second quarter in a standstill from March 31st. After a decent April and May, as the popular broad market averages gained about 2-3 percent, most of those gains were given back in June. True, the stock market as hovering near all-time highs, a static condition for four months now. That’s old news now. We’re all salivating on what’s in store next. Will fear or greed control our investing decisions going forward?

If you divide the stock market into the 9 sectors that S&P publishes, the health of the market is soon diagnosed as not so chipper. Interest sensitive areas such as Utilities, Industrials, and Real Estate, are all well below their recent peaks in prices in late 2014 and late February 2015. Two stand outs we've owned for months now: HealthCare and Consumer Discretionary stocks/ETFs.

The focus in the media is always on stocks, and the casual follower of the markets may be hearing only the headline news. The BIG story of the second quarter was the rise in interest rates, and the toll taken in the bond markets. The confluence of events the past 6 months or so has led to much higher interest rates on longer term debt, which affects shorter term debt. The ending of the Fed’s quantitative easing, or QE, a stronger U.S. Dollar, and then the rise in long-term interest rates.  Why is this important to stock market investors? Higher borrowing costs equate to lower profits. The super low rates have supported profits the past years, and now the rum is being watered down in the punch bowl. Can the end of the stock market party be too far off? Of course, this is just one catalyst that might support a bear market or top in stock prices. But one worth considering as our markets and lives depend in a large part, of being able to borrow short or long term money to accomplish our financial goals.
To wit: in the April-June period, the 10 year Treasury Bond lost 3%, the 20 year T-Bond lost 8%, and the 30 year T-Bond lost 11% ! If a 20 year Treasury Bond loses 8%, and the interest it pays is 2.7%, then 3 years of interest was lost in the last three months owning this bond. Not a good outcome. The bond price/yield teeter-totter has reversed its course; the weight of the higher rates is causing prices to fall. There will come a tipping point in which bond investors will give up all hope and frantically sell their bonds and bond mutual funds. Perhaps that will mark a temporary bottom and an opportunity to buy. If stocks are not behaving well, they will sell stocks, and that doesn't leave many places to hide. The price drop in the U.S. Treasury bonds was quite dramatic, rippling through the many fixed income areas.

Earning an above inflation rate rate on your savings and investments may be a difficult task the rest of 2015 and beyond, unless  you're nimble and can look outside the "box".

There is a touch of good news for savers here: fixed rates on CD's and annuities are rising. The July rates across my desk are more enticing for those who wish to beat the bond markets ups and down, and have stability of principal. Ask me about how that may work to your advantage. Stay tuned.