Higher rates are coming — here's how you prepare
Momentum stocks - from social-media giant Twitter to electric-vehicle maker Tesla to biotech firm Celgene - have run into serious trouble. As a result, investors have piled into low-risk trades again, and strong demand for Treasuries has pushed down yields steadily this year.
After peaking above 3% around New Year's Day, yields on the 10-year Treasury bond are around 2.6% currently.
Some investors may not think that a change of 40 basis points is a big deal. But consider that while rates have drifted down, bond investments like the iShares Barclays 20+ Year Treasury Bond ETF have marched higher. This fund, which as the name implies owns long-term Treasuries, has added 10% in value since Jan. 1 while the broader market is flat.
That's how bonds work; when yields drop, bond prices rise.
But it's important to remember the flip side of that trade - when yields rise, bond values decline. For instance, the TLT fund lost a substantial 17% in value from May through December of 2013 as interest rates on the 10-year Treasury bond almost doubled, from a low of about 1.6% in the spring to 3% after Christmas.
Long story short: If you own any kind of bonds or bond funds, as any diversified investor should, you will be seriously affected by even a modest rise in interest rates.
And make no mistake, they will rise soon.
Here's why you should expect interest rates to move higher - and, most importantly, what to do to keep your money safe.
Why yields will rise in 2014
A choppy market has driven investors back into safe-haven investments. But the short-term volatility can't overshadow a powerful one-two punch that will lift interest rates over the next year: the steady healing of the U.S. economy, and the tightening of monetary policies at the Federal Reserve as the recovery builds.
If you want my case for why things are looking up, just read my recent column on why the U.S. economy is healthier than you think for details on why consumer spending, employment and business trends are pushing higher.
But rather than read the ramblings of a financial pundit, instead consider the fact that the Fed just tapered its bond-buying purchases by $10 billion again in April. Quantitative-easing efforts are now running at roughly half of what they were in December.
Here's the reason for the continued taper, in the Fed's own (near-incomprehensible) wording:
'In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases.'
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