Fear of Rising Interest Rates




Interest rates increase was really a hot topic in last two weeks since US 10 Years Treasury Note hits above 3% for first time since 2014. Market also react negatively with full of comments on interest risk due to this increase.



“Auto loans, home mortgages, and other loans are tied to the benchmark 10-year yield. Investors fear that higher interest rates could start to eat into corporate profits and also signal that more inflation is coming.” This is why everyone is paying so much attention on the 10 years Treasury Note.

Some even talking about “ Inverted Yield Curve….


Below from Investopedia.com :


What is an 'Inverted Yield Curve'


An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession.







BREAKING DOWN 'Inverted Yield Curve'


A partial inversion occurs when only some of the short-term Treasuries (five or 10 years) have higher yields than 30-year Treasuries. An inverted yield curve is sometimes referred to as a negative yield curve.

Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle. A recent example is when the U.S. Treasury yield curve inverted in 2000 just before the U.S. equity markets collapsed. An inverse yield curve predicts lower interest rates in the future as longer-term bonds are being demanded, sending the yields down.


Yield and the Economy


The shape of the yield curve changes in accordance with the state of the economy. The normal or up-sloped yield curve may persist when the economy is growing and conversely, the inverted or down-sloped yield curve is likely to press on when the economy is in a recession. One underlying reason such a relationship exists between the yield curve and economic performance relates to how a higher or lower level of long-term capital investments may help stimulate or rein in the economy. By issuing longer-term securities with lower-yield offerings, businesses and governments alike can acquire needed investment capital at affordable costs to jump start a weak economy.



< Inverted Yield Curve>




More reading on Inverted Yield Curve :


Yield Curve Inversions and Stocks Are a Toxic Mix ( from Bloomberg.com by Ben Calrson)



A Flatter Yield Curve Is No Reason to Freak (from Bloomberg.com by Barry Ritholtz )


So, one thing for sure is that we have seen rising interest since last year and is going to continue (in slow and accommodative pace) increase in next two years according to US FED.  Economics 101 teach us that rising interest rate will increase our borrowing cost and is bad for those with higher gearing or debts. 

One of my friend recently asking me if he should sell off all his REITs as interest rates increase is bad for REIT where their borrowing cost shall increase and worse still if the REITs are not able to increase the rent or operating income to mitigate the higher interest cost.

First of all , I told him that if he is holding all his equity in REITs only , then may be he should consider to diversify some to non-REIT sectors. Readers may know that I have been reducing my exposure to REITs from as high as more than 80% in 2014 to now about 47% in my portfolio.

Well, we also know that rising rate means improving economy situation and some sectors will perform well in rising interest rate environment e.g. Banking and ….


Obviously, not all REIT will underperform in such a situation if the supply / demand were in their favor where it could fetch a higher rent due to better economy and demand in certain sector ( sub-sector in REITs).  Also, the lease structure (e.g longer WALE with fix escalation rent) or percentage of debts in fix rate vs floating etc…which may act as cushion on impact from this cost increase.

How Do Market Interest Rates Affect REIT Returns? From Nareit.com



….and most important thing :


Do REITs Have Moats? From  Seekingalpha.com




Ultimately, having a more diversify portfolio will let you have a peace of mind although you will not have spectacular return even with 1 or 2 multi-bagger in your portfolio.

My portfolio’s YTD return is only 1.8 % as compared to STI of around 6.1 % but I could sleep well at night.



For some of us , rising interest rate might have impact if we still have outstanding mortgages / car loan / student loan / credit card balance etc , under such circumstance ,one will need to be prudent on your “ balance sheet “ and not to overstretched on your debts.



Cheers !!





“It’s not what you own that will send you bust but what you owe.” By Anon

Comments

  1. Hi STE,

    Fortunately enough, I do not have any exisiting debt which will impair my balance sheet from the rising interest rates. But I guess it’s too early for me to even talk about it yet!!

    Having that said, it might seem much better for cash rich company today as they require much lower borrowing cost than those who needs the utilize on borrowings to fund their business or investments!!

    ReplyDelete
    Replies
    1. Hi sleepydevil,
      Great !! glad to hear that you are in very good shape on your "balance sheet" , yup, those cash rich companies may be in better position than those having high debts or gearing , but at the same time they may also having problem of how to utilize the cash in more efficient way ,,if there is no better investment out there ... should they pay more dividend or having share buyback program ?? ummm...
      Cheers !!

      Delete
  2. when the US TB hit 3%, many economist is suggesting that as long as the economy is growing then the market should be supported. so question is what wld be the number that trigger a more serious signs of market is heading into recession

    ReplyDelete
    Replies
    1. Hi XIY,
      That's very true , the 3% is just a benchmark to compare the long term average interest rates , the figure should not be deemed as a "magical number" to gauge when will recession come , in an irrational market, the rates could go much higher before market or economy's direction turn , as you said , there must be a " trigger point " or events that make the make the chance from full optimism to pessimism ...that's " mr market "
      Cheers !! :D

      Delete

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