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Combating Rising Interest Rates
The 10-year Treasury is the most liquid and widely traded bond in the world. Since hitting a low of 2.04% in September, its rate has been climbing, reaching a high of 2.90% today. Similarly, the rate on the 30-year bond has been rising, and on Monday it reached its highest rate (3.14%) since March of last year. Bonds have faced selling pressure as a mixture of inflation concerns, growing budget deficits and the Federal Reserve's unwinding of its balance sheet have weighed on demand. But are falling prices (and therefore increasing yields) such a bad thing?
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10 Year Treasury Rate, through 2/13/18
Source: Macrotrends.net
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Bond investors are understandably concerned. If interest rates shoot up, the market value of bonds will drop sharply, with prices falling to bring yields in line with the new, prevailing higher rates. To offset those fears, we often hear: "Well, if I just hold my bonds to maturity the short term price declines won't matter." But investors who don't take advantage of trading opportunities when yield curves are as steep as they are now, may be missing out on extra return. The source: Rolling Down the Yield Curve.
Roll Yield
Rolling down the yield curve involves the purchase of a bond with a maturity
in the higher yielding section of the yield curve, and selling the bond prior to maturity when it reaches a lower yielding section.
The strategy can benefit investors by providing:
1.
Higher incremental income:
By purchasing relatively higher yielding bonds
2.
Higher principal proceeds at sale:
Depending on the characteristics of the bond, a capital gain or reduced capital loss
3.
Declining bond price volatility
as the bond moves closer to maturity.
An Illustration
Assume, in 2017, you invested $100,000 in a 15-year bond paying 3%. If you held it to maturity, you'd receive a 3% annual return. Then assume interest rates rise by 50 basis points (0.50%). After 10 years you have 5 years remaining. At that time you could sell that original bond for a premium of $104,640 (because 5-year bonds are paying less than the 3% coupon your bond has) and put those proceeds toward a new15-year bond with a higher coupon. By 2032, your portfolio would be worth $109,632 and your total return would be 3.74%. More than if you'd held the original bond, even in a rising interest rate environment.
The bond characteristics and corresponding cash flows are shown below:
Using techniques like rolling down the yield curve make it more likely that bond investors will come out ahead, even as interest rates begin their inevitable rise. Active fixed Income managers will employ techniques like these. Investors who hold individual bonds in their brokerage accounts will not.
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It was a wild week for equities as all the major equity indexes fell in tandem and entered correction territory. The
selling was related to fears about rising inflation/rising interest rates and the realization that stocks have gone too far, too fast. Although media attention focused on the narrow Dow Jones, which had two separate days of 1000+ point drops, the percentage declines were less imposing. The market's sharp decline stood in contrast to continued favorable news about corporate earnings and economic fundamentals.
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> Inflation:
With equity investors skittish about the potential for rising inflation and rising rates, today's CPI report will likely be scrutinized. Not much price traction was expected for January, with the year-over-year Core CPI (ex-Food and Energy) expected to come in between 1.7% and 2.0%. It was reported today, in line with expectations, at 1.8%.
> Valuations:
Even after the recent equity market declines, the cyclically adjusted price-to-earnings, or CAPE, ratio for US stocks stands at 32 times, according to data compiled by Yale professor Robert Shiller. That's still nearly double the long-term average of 16.8 since 1881. To put that in perspective, the S&P 500 would have to fall to 1,380 (or an additional 52%) just to reach its long-term average valuation.
> The Cost of Love:
Love it or loathe it, Valentine's Day is an important date for the US economy. According to the National Retail Federation, the average American will spend $143.56 on gifts this year, with total planned nationwide spending $19.6 billion.
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Source: Statista Charts and National Retail Federation
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Most are awarded for speed skating where 14 medals will decorate the best athletes.
One gold medal weighs 586 grams, so the total weight of gold medals awarded will be close to 60 kilograms, about 132 pounds, the weight of 5 standard gold bars.
102 events is the most ever for a Winter Olympics. By comparison, the Salt Lake City games in 2002 had 78 events, the games at Squaw Valley in 1960 had 27 and the first Winter games in Chamonix had just 16 events.
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New Market Wealth Management offers modern investment solutions backed by extensive research and experience serving the needs of wealthy families. Through our strategic partnership with
Cliffwater LLC
, we have access to institutional-quality research, investment due diligence and asset allocation tools. We believe this level of experience and unique access to in-depth, sophisticated research are essential for success in today's complex world markets.
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