Fear of Rising Interest Rates

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

10-year Treasury yield hits 3% for the first time since 2014 from CNN Money.com

Why everyone is stressing about the 10-year Treasury yield from CNN Money.com

“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 to the 10 years Treasury Note.

Some even talk 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.

image credit to investopedia.com

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 the Inverted Yield Curve :

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

 Fed Study Finds Inverted Yield Curve Still Good Recession Alert (from Bloomberg.com by Alister Bull )

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 the next two years according to the US FED.  Economics 101 teaches us that rising interest rate will increase our borrowing cost and is bad for those with higher gearing or debts. 

One of my friends recently asked 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 maybe he should consider diversifying 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 economic situation and some sectors will perform well in a rising interest rate environment e.g. Banking and ….

These Sectors Benefit From Rising Interest Rates from Investopedia.com

Obviously, not all REIT will underperform in such a situation if the supply/demand were in their favour where it could fetch a higher rent due to a better economy and demand in a 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 a cushion on impact from this cost increase.

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

REFILE-REITs outperform broader market in rising rate environment From Reuters.com

….and most important thing :

Do REITs Have Moats? From  Seekingalpha.com

Ultimately, having a more diversified portfolio will let you have 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, the rising interest rate might have an 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 !!

Quote Of The Day :

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