Why You Should Care About Wednesday’s Bond-Rattling

Stocks pushed higher on Wall Street on Wednesday as a rebound in Apple (AAPL), after the initial disappointment with Tuesday’s iPhone 6/Apple Watch unveiling, was largely reversed with some very orderly, machine-like buying in the tech giant. Also helping the bulls was a “No” majority in another one of those Scottish independence polls that has the Europeans suffering a cold sweat. Overall, the Dow Jones Industrial Average gained 0.3% after testing below the 17,000 level for the first time since mid-August and threatening to fall through its two-month trading range. The S&P 500 gained 0.4% but was unable to retake the 2000 level. Yawn. It seems like the stock market’s summertime doldrums continue. But it wasn’t the same story over in bonds, with fixed-income traders being rattled by the worst volatility in months. Crude oil was also punished, with West Texas Intermediate losing another 1.2% to close below $92 a barrel for the first time since January. There’s a common thread here, and it has to do with the U.S. dollar and the Federal Reserve. The connection is that the market is slowly awakening to the fact that the Federal Reserve is moving ever nearer to finishing its QE3 bond purchase program (which started in 2012 and is due to end next month) and will start raising interest rates sometime in 2015, probably in the first half of the year. JNK Click to Enlarge This — in combination with various issues in foreign currencies from weak Japanese economic data to new stimulus measures from the European Central Bank and the aforementioned Scottish independence vote — has been bolstering the greenback in a big way. And that’s good for consumers, since lower fuel prices will help support holiday shopping. But the realization that the Fed is poised to raise interest rates for the first time since 2006 is pushing up interest rates and pushing down bond prices. Just look at the chart of the Barclays High Yield Bond SPDR (JNK), which is suffering its most aggressive selloff since July. There is one school of thought that says bond weakness can be a positive for stocks because it encourages investors to pull money out of bonds and put it into stocks — especially if the reason interest rates are rising is because of a stronger economy. But given that short-term interest rates have been near 0% since 2008, and that the Fed has taken the monetary base from $800 billion to more than $4 trillion, this is far from a normal economic cycle. To be honest, no one really knows what will happen when the Fed pulls the plug. But one thing is clear: The stock market has been enjoying a steady injection of cash from the bond market as CEOs have been using low interest rates to raise money by selling bonds before turning around and using the cash for share repurchases. Since their pay and performance metrics are tied to things like share price and earnings per share, it has been in their personal interest to do this. And investors have had little reason to complain. The trouble is, there is already evidence the flow of money is stopping. And that suggests stocks could lose one of their major sources of support in the months to come. XLE Click to Enlarge For now, I recommend investors profit from emerging areas of weakness such as energy stocks via inverse ETFs including the ProShares UltraShort Oil & Gas (DUG), which is up 2.4% for Edge subscribers since it was added earlier this week, or put option positions in stocks like Schlumberger (SLB), with Sep $106 contracts up 92% for Edge Pro subscribers since last week. Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.

Article printed from InvestorPlace Media, https://investorplace.com/2014/09/bonds-jnk-xle/.

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