How to Trade Taper Tantrum Part Deux

The sell-off in income stocks is a buying opportunity

   
How to Trade Taper Tantrum Part Deux

Good economic data comes rolling in … and the market throws a taper tantrum.

The ADP payroll report showed that 215,000 jobs were created in November, well ahead of the consensus expectation of 173,000, and October’s figure was revised from 130,000 to 184,000. Adding to the rosy outlook, initial claims for unemployment fell to 298,000 last week — much less than the 325,000 expected by the Street and the lowest reading in two months.

So, businesses are hiring again … and fewer workers are getting laid off. We’ll see if this is reflected in the unemployment numbers to be released tomorrow; the consensus estimate is that the unemployment rate will fall from 7.3% to 7.2%.

Yet in the good-news-is-bad-news, Fed-obsessed environment we find ourselves in today, this steady stream of good news has seen the S&P 500 decline every day since Thanksgiving.

By now, you probably know the reason: Tapering, or more accurately, the fear of what a scaling back of the Fed’s bond-buying program means for the capital markets.

With no recent guidance from the Fed, the market is bracing for the worst-case scenario — a tapering timeline that starts this month, following the Fed’s Dec. 17-18 meeting. This lingering unknown has sent the 10-year Treasury yield to nearly 2.9%, just a hair below its September high.

And remember, rising bond yields mean falling bond prices. All else equal, it also means falling stock prices, as bond yields are a major component of all discounted cash flow pricing models (the discount rate is based on the bond yield).

The declines in the broader stock market averages have been pretty mild — the S&P 500 is down about a percent since November 29, and the Dow is down about a percent and a half — but several “bond-like” stocks are down sharply. Realty Income (O), one of my favorite long-term dividend payers, is down more than 4% over the same period and is now hitting new 52-week lows.

Mortgage REITS are also getting hammered: Annaly Capital Management (NLY), one of the largest and most liquid mREITS, is close to touching a new 52-week low and now trades at a 21% discount to its book value.

So, where do we go now? Do bond yields march inexorably higher, laying waste to all income investment as they rise?

I wouldn’t bet on it. I’ve been pretty consistent in my view that, taper or no taper, bond yields are going to remain fairly low by historical standards. I see the 10-year yield bouncing around in a range of about 2.00% to 3.25% over the next five years or so. My advice throughout the past seven months of “taper tantrum” has been to load up on income investments whenever we get near the top of this range, using the price volatility as a buying opportunity.

And I’m not the only voice in the wilderness here; Jeffrey Gundlach, perhaps the best bond fund manager of his generation, commented in last week’s Barron’s that believed yields could hit new lows. The lack of inflation and a lack of credit growth in the private sector (and a narrowing of the budget deficit too for that matter) all point to lower yields. And remember, while the Fed may start tapering in the coming months, the Bank of Japan and European Central Bank have given every indication that more quantitative easing is to come.

So, I repeat: use the recent yield spike as an opportunity to scoop up your favorite income investments. If you want to take a modest risk, follow Gundlach’s advice and accumulate mortgage REITs. Your easiest one-stop shop during the market’s taper tantrum would be the iShares Mortgage Real Estate ETF (REM).

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long O. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends.


Article printed from InvestorPlace Media, http://investorplace.com/2013/12/trade-taper-tantrum-part-deux/.

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