Don’t Let Your Portfolio Get Crushed by Rising Rates

Steve McDonald By Steve McDonald, Bond Strategist, The Oxford Club

Two-Minute

Transcript:

The markets have been on fire lately, and that’s what I’m focusing on in this week’s Two-Minute Retirement Solution.

For stocks, it’s been a good thing. But for Treasurys, it’s not so good.

And we’ve seen lots of selling in bond funds, too!

Here’s why it matters to income investors…

The bond funds most people have been buying (to make up for near-zero returns on CDs and savings accounts) are the ones offering the highest yields. No one goes out and buys funds with the lowest or most reasonable returns.

That’s just the nature of most bond-fund investors.

And until last week when the sell-off in Treasurys began (the 10-year saw a massive 23% yield increase in one week), this strategy worked fine.

But it won’t work going forward.

The stock market’s good news will drive up inflation and rates, which will crush bond funds that have performed well to date.

Let me explain how…

To achieve the high yields that have attracted investors for the past four years, fund managers had to hold long-maturity bonds and leverage them. That’s how you can get 4% or 5% in a market that’s paying 1% or 2%.

And as long as interest rates held steady, that was a good strategy.

But if the market likes Trump’s pro-growth ideas as much as last week’s action suggests, rates won’t hold steady much longer.

And as they increase (the Fed will likely raise them in December), it will impact bond prices. Specifically, the longer the bond’s maturity, the greater its drop in value.

The cost of leverage also increases when interest rates rise. And it comes right out of your share value.

With the value of the underlying bonds dropping, the cost of the borrowing also goes up. That’s strike two.

Liquidations are going through the roof, which means that managers are selling bonds into a falling market to cover the cash that’s needed for those liquidations.

And that’s strike three.

I have been warning about this scenario for five years. It had to happen, and now it has.


The good news is individual corporate bonds do not react to the threat of rising rates as much as municipal bonds and Treasury bonds do.

For example, then the yield on the 10-year Treasury ran up 23% last week, my corporate bonds held steady, plus or minus one point.

If you need bonds for income, this is where you have to be.

The only thing to do now is to get out of any funds with long-maturity bonds and leverage, and instead, hold short-maturity corporate bonds.

It’s the only way to make money and avoid the bloodbath that’s going to hit bond funds and Treasurys.

Do it now or get ready for a real beating.

Good investing,

Steve

P.S. If you’re interested in short-maturity corporate bonds that’ll be able to withstand rising rates, check out my trading advisory, Oxford Bond Advantage. I issue brand-new recommendations each month, and you can find out how to access the full portfolio by clicking here.