Interest rates may have reached its end for US and Canada. Alongside is an imminent end of the bull market bond after 33 years in the economy.
A familiar pattern can be highly useful when joining the game of stocks: interest rates drop, bonds rise, and leads to the creation of a bull market. Lately, we’ve been seeing drops in bond prices, and rises in yields. These events are hints of the start of a bear market for bonds, and the rotation of soaring interest rates.
The cycle’s turnaround is a crucial and a significant event for individuals involved in the markets. Reversal of interest rate trends only happens three times in each person’s lifetime. Thus, it’s important to prepare for such events. Taking notes and creating strategies are the best moves one can take to be able to save their self from possible negative effects. Being cautious and aware of the situation can also help your business and portfolio to benefit from this trend.
Circumstances following the 2008 financial crisis led to a S&P 500 drop. After the crisis, banks all over the world have been printing money and have been following an “easy money” policy with the most minimal fear of inflation. On the other hand, while US and Europe undergo an anemic economic recovery rates, the Federal Reserve Board’s Open Market Committee (FOMC) showed hints indicating a start of reducing the quantitative easing (QE) program, which threatened North American equity markets. These events caused a 4.8% drop for the S&P 500 in just four days; the worst ever over a span of 20 months.
The Fed’s announcement was released last year in September. However, no tapering activities have begun just yet. Many believe it’s just a matter of time before the tapering starts.
Although, markets are anxious about the end of the Fed’s easy money policy and bond buying program, it’s true that a better economy will emerge once these changes occur. It’s good news; an economy that doesn’t rely on life support means a stronger economy, and for stock markets, it means improved profitability for businesses.
A safe, steady market may sound enticing. For years, we have been accustomed to this type of economy that provides stable and low interest rates. For instance, Canada has the same rates since September 8, 2010. While US rates haven’t shifted since December 16, 2008.
Recently, an upturn in bond yields had turn apparent. After 10 years, when the U.S. Treasury bond yields dropped to 1.43% last year, it resulted in a 2.98% yield rise on September 5, 2013. It’s the highest surge since early 2011. Many financial experts believe that once the 10-year yield rises to more than 3%, it will be the start of the trend reversal.
Together with the recovering global economies, these are clear signs that short-term interest rates will rise, too.
Therefore, instead of wasting time being afraid of the upcoming reversal trend, what we need to do is prepare for this change. We can profit from this reversal through careful planning.
The rise of interest rates will bring impact to your investment portfolio, real estate market and corporate profitability. Placing fitting strategies for each of these areas will be anyone’s best tool to adapt and gain profits from the cycle turn.
Interest Rates & Your Investment Portfolio
Reversal in trends would initially bring negative effects to markets. Rising interest rates may be taken as bearish signals for stocks. However, markets typically recover in just a few months, and returns could even improve because of better corporate profitability.
In 2007-2008, a bullish signal took place, which may happen again in the coming days. In 2009, a widening yield curve emerged, which can also be one of the bullish signals for stocks and the economy at this point. In September 20, 2013, the gap between US 2-year and 10-year Treasury yields expanded to 2.41%, or 241 basis points, which could be similar to a rising yield curve at 121 basis points last year.
We could be wrong, of course. The steeping yield curve last year could be short-lived, and can change when short term interests arise. But if the snowballing of yield rise end exceeds the short end rise, the growing yield curve may stay intact.
In 1897 and 1942, when rates reached a bottom after a long secular drop, it created a secular bull market in the stock market.
During 1897, interest rates reached a bottom after a 30-year drop. During the same time, a cycle of rising rates took place which clashed with the start of a secular bull market on Wall Street. These events lasted until the 1929 market crash, and the beginning of the Great Depression. All this happened again in 1942.
The change in the cycles requires you to have new strategies for your portfolio. You may hold on to short term maturities, and move to your GICs and bonds as they mature. This will allow you to invest the maturities at higher interest rates as they build up. Keeping the maturities short term will also help you avoid capital bond losses, which is quite inevitable in an environment with rising rates. The longer you keep maturity bonds, the higher the capital loss because of heightening rates.
Interest Rates & Real Estate Market
The real estate market tends to suffer from negative consequences when interest rates rise. When interest rates go up, mortgages become less affordable, causing a cool down on the activities of the housing sector, which eventually leads to decrease in prices.
Although, there have been a buying spree in the real estate market when buyers wanted to assure their mortgage rates before further rate increases occur, it may end shortly when a consistent rising trend starts. Activities in the mortgage and real estate market may begin to cool down as a result.
Since 1996, the real estate market has experienced a bull run, which is longer the most of the previous bull runs in the US. Therefore, this is the best time to reconsider your real estate holdings, and begin gaining profits from properties that have good appreciation. You may also want to assure your mortgage rates at the on-going low rates before the trend reversal heats up.
This is also the time to reduce mortgage debts because higher interest rates mean higher costs. During a trend reversal, real estate rates go lower, which means it’s not the best time to sell properties. You must be sure that you can afford mortgage rates even if rates rise above 3 to 4% and higher than their current rates. According to cbj.ca, “While the interest rate rises in store may be more muted, rates did rise 4.25% from June 30, 2004 to August 17, 2007 and they rose 3% from February 4, 1994 to July 6, 1995.”
Interest Rates & Corporate Profitability
A better economy means a better environment for businesses. It also means consumer spending rises, as well as abundance in businesses’ capital spending. These are good news for corporate profitability.
One side effect of an improving economy is rising interest rates. When rates go up, financing costs rise, where corporations with high debts suffer due to bigger financing costs. The time that bond yields rise, corporations will have to offer higher rates on their bonds to attract more investors – a painful event for corporations.
The best move is to reduce corporate debts that will help you prepare for a new environment with high rates. If you are planning to start a new venture, the earlier you kick off and the longer guarantees you have for your financing rates, it may allow you to have a more secured, lower rates for financing.
On a positive note, it’s a good step to have new ventures in a growing environment. It could be more profitable as it can make up for higher borrowing costs.
Study the changes that happened in the history of interest rate trends, and make modifications based from it. Use them for your business, investment and real estate portfolio. Eventually, the changes will pay dividends in the long run.
