Spiking rates: A Wake-up call?

A simple spike in rates

That’s all that did it. A jump of the rate on the U.S. 10-year from somewhere in the 1.80% range to slightly above 2.10% and sure enough it was as if someone turned off the music and you had to find a chair.

Many investing folks didn’t really appreciate the move and the resulting sentiment change was noteworthy. 

So what happened?

Well, the U.S. 10-year Treasury note is considered one of the most risk-free assets out there. One may debate whether that still holds true in light of the massive amount of debt being accumulated by the world’s richest nation, but we’ll save that for another time. Over the past, call it eight months to a year, investors have been substituting the fixed income portion of their portfolios with higher-yielding dividend stocks, utilities, telecom and REITs being the primary beneficiaries of that inflow of capital. When rates spiked recently, these investments became far less interesting, call it “riskier”, given that the “risk-free” asset was now paying a higher rate of interest, as a result all of these assets took a hit. 

So what to do? 

If you are an investor, as opposed to a trader, examine your portfolio. Are you sitting with an overweight position in utilities, telecom and REITs, if so, ask yourself whether that trade is going to continue, unless you purchased these things in the last 60 days, you should be showing a nice gain. I think the spike in rates was a precursor to future movement, however, incredibly premature. Even the jobs number bears that out in that the U.S. economy generated 175,000 jobs in May. An economy chugging on all cylinders would be creating closer to 400,000 jobs monthly. So in other words there is nothing from a macro-economic sense pushing rates higher.

What this also means is that you should be looking at your fixed income holdings very closely. If you characterized these dividend paying stocks as fixed income, please review that decision. Some of the perpetual preferred shares (those that do not reset at a market rate) may be adversely affected rising rates, so review those as well.

Even those bonds that have been great for many years will lose value in a rising rate environment. Remember, as yields rise, bond values fall, so don’t be surprised if the value of your bonds decline during the time until maturity. Now, leaving aside the fact that perhaps the issuer will not be able to repay the bond, which is an entirely different matter, you need to ask yourself whether you can sit tight with a bond paying four percent when rates begin to climb beyond that amount.

Whether it happens in two weeks, two months or two years, interest rates are going up. What happened this week, however, was a sharp reminder of how such a move affects your portfolio. All I am advocating is that you should be ready for it and act accordingly.

David Lisbona, B.C.L., LL.B., MBA, FMA is an investment advisor at RBC Dominion Securities, he can be reached at (514) 840-7130 or at david.lisbona@rbc.com