If you have been an investor for 30 years, you don’t know about interest rates.
I have been covering business for almost 40 years, and the memories remain clear. At the start of 1979, the U.S. 10-year bond carried an interest rate of 9.1%, on its way to a peak of nearly 15% in 1982. Then Fed Chair Paul Volcker kept it high to wring inflation out of the system. When I bought my first house, in 1984, my mortgage was at a floating interest rate of 13%, with the 10-year bond floating at 11.7%.
With money so expensive, real estate was cheap. The home I bought for $49,500 then is worth 10 times that now. The 10-year bond, meanwhile, hasn’t averaged over 3% since 2011.
Cheap money has kept asset prices high, and the Dow Jones Industrial Average is up over 200% from its 2009 lows. The Nasdaq Composite is up almost 360%. During this decade, you could throw a dart at a stock chart and come up with winners.
If interest rates are rising, however, that won’t be the case. You are going to take a beating if you don’t take some action. The following are some actions you can take.
While growth stocks fail in the face of rising inflation, dividend stocks pay you to own them.
With its recent dividend hike to 20-cents-per-quarter, Ford Motor Company (NYSE:F) was trading March 1 with an implied yield of 7.8%. If we are moving to hat-sized yields, that’s a big hat. If you don’t like cars, or don’t trust their earnings (Ford covered their dividend with earnings nearly three times in 2017), consider AT&T Inc. (NYSE:T), whose 50-cent-per-share dividend was yielding 5.56% on that date.
The price of dividend stocks may not rise with interest rates, but they should prove less vulnerable than those stocks that don’t pay dividends. Back in the early 1980s, a 5% yield was considered average. Boards had to pay their investors because otherwise they didn’t have any.
Dividend stocks aren’t an “ultimate solution” to market risk. They can go down in price. But so long as there are enough earnings to pay the dividend, your downside risk is limited. They are a defensive play and that’s the point.
Since the start of the Trump Administration, bank stocks have been on fire, in hopes of higher interest rates.
This is why JP Morgan Chase & Co. (NYSE:JPM) is up almost 23% in the last year, and why Bank of America Corp (NYSE:BAC) is up 25%. Investors concerned about rising rates have already gotten into these names, raising BAC’s price-to-book to 1.31, when for years it was at .75 and below. JP Morgan, which once traded at around 10 times earnings, is now trading at over 16.
Banks capture higher interest rates because they are buying and selling money. They will delay raising the prices paid, to depositors and holders of CDs, for as long as possible, and increase the price paid by borrowers as quickly as possible.
As interest rates rise, the move toward bank stocks is only going to accelerate. Back when interest rates were measured in the teens, banks did very well. They should do well again as rates rise.
Precious metals, oil and other hard-to-substitute commodities all did well in the 1970’s. Hard assets benefit from inflation because they may rise in value while they’re in storage.
Gold, silver, platinum, aluminum and palladium all hold up well when inflation is high,
While a single gold stock like Randgold Resources Ltd. (ADR) (NASDAQ:GOLD) might fit the bill, it crashed with the market in early February after failing to meet earnings expectations.
You can avoid those kinds of problems by investing in an ETF that buys stocks in several precious miners, like the Powershares DB Precious Metals Fd (ETF) (NYSEARCA:DBP), mentioned recently by InvestorPlace contributor Lawrence Meyers, or the SPDR Gold Trust (ETF) (NYSEARCA:GLD), which has over $35 billion in assets. The bigger the fund, the more stable it will be, and the better it will likely reflect the health of the industry it follows.
Floating Rate Bonds
There are some bonds that pay investors more automatically as interest rates rise.
Treasury Inflation Protected Securities (TIPS) were first issued in 1997, and are currently available in durations of 5-30 years. Small investors can buy inflation-linked savings bonds, or iBonds, directly from the U.S. Treasury.
TIPS are designed to pay only 1.5% interest, but that is on top of inflation, which is measured every six months. Even at 2% inflation, a taxable portfolio still needs to earn 4-5% to break even, so TIPS can maintain the value of your portfolio even better than cash and minimal downside risk.
Another route for bigger investors are exchange-traded funds (ETFs) that trade floating rate corporate bonds like the Guggenheim Floating Strategies Fund (ETF) (NYSEARCA:GIFIX), which puts at least 80% of its net assets in floating rate instruments and has a five-star rating from Morningstar.
It’s important to remember, when inflation rises and the economy tumbles, that cash, too, is an asset class.
Europeans understand this well. Over the last year, the Euro has risen from $1.06 to the U.S. dollar to its current level of $1.23. A European investor whose U.S. stocks gained 10% in value over the year is sitting on a loss. But a U.S. investor who had his money in Europe has a gain, even if the value of those stocks fell 10%. Thus Volkswagen AG (ADR) (OTCMKTS:VLKAY) has been a big winner over the last year, up 25% even though you’re buying in dollars.
Currency has helped fuel my own decision to go long on China. The value of the Chinese currency, the Yuan, has risen in the last year from 6.8 to the dollar to its current level of 6.35. That’s a gain of nearly 10%, so just keeping money in a stock like Alibaba Group Holding Ltd (NASDAQ:BABA) has been profitable.
Investing in a foreign economy can be dicey, of course. Exchange traded funds are the solution in many smaller economies, like India. I have owned some of the IShares MSCI India ETF (BATS:INDA) since last July, and that shows a small gain, plus a cash dividend.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in F, T, BABA and INDA.