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To print article, click Print on your browser's File menu. Go back Posted 11/14/2003 |
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Extra! The rate-hike countdown has begun Greenspans hint that interest rates will have to rise sent bond markets into a tailspin. Rising rates will take their toll on junk bonds, mortgage-backed real-estate investment trusts and oil and gas partnerships, too. By James B. Stewart The macroeconomic news has continued to make headlines, with last week's employment report of 120,000 new jobs in October buoying expectations for further strength. Thus it might seem paradoxical that after hitting new highs last week, the stock market experienced at least a modest sell-off. It's not. The not-so-silver lining to all this good news on the economic front can be summed up in two words: interest rates. Although the Federal Reserve has pledged to maintain short-term rates at current, historically low levels for the foreseeable future, remarks by Chairman Alan Greenspan last week hinting that at some point rates would have to rise sent bond markets into a tailspin. The 10-year Treasury now yields 4.4%, up a full percentage point from its low. What to expect when interest rates rise Higher interest rates obviously hurt the prices of bonds, which have had a terrible year. If you've been reading this column with any regularity, you've been amply warned that this was likely to happen, and hopefully you've avoided most bonds. But at some point rising interest rates also will take their toll on stock prices, since higher rates increase the cost of doing business and eventually depress earnings. While it seems awfully early in the economic cycle for that to be surfacing, no doubt some investors are looking far into the future and don't like the higher interest-rate environment they see.
But I'm less concerned about the near-term direction of stocks than I am of my interest-yielding investments. While I've avoided Treasurys and investment-grade corporate bonds for some time, I have recommended in this column some high-yield alternatives: junk bonds, mortgage-backed real-estate investment trusts and oil and gas partnerships, to name three. Grim future for interest-yielding investments Nearly all of them have performed fabulously this year, as investors sought higher yields and an improving economy lowered the risk of default, in the case of junk bonds, and increased demand for energy, in the case of the partnerships. The mortgage-backed REITs have benefited from a steep yield curve. Remarkably, despite the recent rise in interest rates, my junk-bond funds and oil and gas partnerships have been hitting new all-time highs. Only the REIT has sold off, and not by much, considering that it still yields a very tempting 13%. Nonetheless, at some point rising rates will take their toll -- and that makes me nervous. So far I haven't sold anything. The REIT I own, Annaly Mortgage Management Given the Fed's latest remarks and the strength of the economy, I'm more concerned about a further rise in longer-term rates, which could actually make the yield curve steeper -- something that would be good for Annaly. So I'm holding on for now, and if I didn't already own some, I might well be tempted by the remarkably high yield. But if shares drop below $15 or so and stay there for awhile, I'll probably bail out. And surely the run in oil and gas partnerships and junk bonds won't last forever. In many cases yields have fallen to the point where they're only a few basis points higher than comparable Treasurys. It's tempting to lock in some profits now, but I don't mind giving up a little in capital gains in order to keep the income flowing from these securities. Still, I wouldn't add to any holdings at this point, and will be keeping a close eye on the market for signs of any long-term erosion. Then it will be time to realize the gains. For market commentary every day, visit SmartMoneySelect.com. |
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