- The end of Quantitative Easing (QE) will spell the end of the post-financial crisis recovery of the U.S. economy with a spike in interest rates and hard times for the stock market. It did not happen. Here is a link to what we were saying in December of 2013 that may add credibility to our post today.
- When rates do rise, the dollar will soar vs. other currencies, making U.S. goods more expensive in global markets and imports more affordable, thus further damaging the U.S. economy. This already happened and may be in the process of reversing, just as a Fed fund rate increase seems to be a fait accompli. The dollar actually took a significant hit on Janet Yellin’s recent comments before Congress, which appeared to indicate a strong inclination to raise rates at the December meeting. European Central Bank President, Mario Draghi, reinforced the move by stating Europe did not seem to be needing greater quantitative easing at this time. Of course, he is ready to intervene further, if conditions deteriorate.
- Bond prices will collapse causing yields to soar on ‘lift off’. Ergo, mortgage rates will soar, killing the U.S. housing market. On the eve of an increase in the funds rate this does not appear to be the case. December 18, 2013, the Fed announced they would begin to taper the bond-buying program ($86 billion per month) we all grew to love and fear as Quantitative Easing. The 10-year U.S. Treasury (Tsy) yield spiked to a bit over 3% (and has not been that high since). The 10-year closed 2013 at 2.88%. The S&P closed 2013 at 1848.36 (with a 1.9% yield). On Friday, December 4, 2015, the 10-year Tsy closed at a 2.27% yield. 30-year mortgages closed 2013 at a 4.46% yield. As of December 4, 2015, 30-year mortgages are available at a 3.63 % rate. It is doubtful the potential bump in the FF rate will take this rate anywhere near the previous two-year high. BTW, the S&P closed 12/4/2015 at 2191.61 (+18.3% over the two year period, still yielding about 1.9%).
- Finally, because of expected higher rates, investors need to avoid companies that use high degrees of debt in their capital structures (REITs, BDCs, MLPs, Utilities and high-dividend payers), because debt will be more expensive in this rising rate environment. As it pertains to dividend stocks in general, higher fixed income rates will make fixed income more compelling versus stocks. Oh yes, Banks will be the big winners because higher short rates will allow them bigger interest spreads, much better earning power. Though the rate increase, de minimis as it may be, has not yet happened, a big downward move in the leverage plays has already taken place. Meanwhile, everybody loves banks. This creates a mismatch, which coupled with year-end tax-selling, could provide some real opportunities.
One Last Point on Interest Rates
They are going up. The question for many is, “How much?” Because sovereign 10-year rates in most of the major developed countries are very much lower than in the U.S. 10-year, the U.S. Tsy 10-year is the best house in a so-so neighborhood. If you check the table below, you will see why there should be a good, strong international demand for our debt, again keeping a lid on the potential upward move in long rates.
Ten-year Sovereign Debt rates (as of 12/4/2015–Source, Wall Street Journal)
US Tsy 2.276%
Hard to believe as it might seem, Portugal, with all its problems, only has to pay 20 basis points more in rates for 10-year money than the United States Treasury.
Hopefully this undoing of conventional wisdom helps you feel more comfortable with the market going into the new year.
How are you feeling?
The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. All investments and strategies should be undertaken only after careful consideration of suitability based on the risks, tolerance for risk and personal financial situation.