When Interest Rates Climb, Bond Prices Decline

A fundamental law of finance is that when interest rates rise, all other things being equal, the price of interest bearing securities decline. Of course, all other things are never equal and that’s when it gets complicated.

Income strategies generally underperform when the threat of higher interest rates is a concern. In 2014 and part of 2015 the negative impact on income strategies was intensified when the price of commodities, primarily oil, declined sharply. Since many yield investments are ultimately based on the price performance of energy and other commodities, this presented a perfect storm for some yield investors.

It turned out that the Fed only raised rates once in 2015 and have been on hold in 2016. This led to better performance in yield securities in 2016 until recently, when we are once again seeing pressure on these stocks. Leading up to the election, the backdrop was the likelihood that the Federal Reserve would raise rates at its December meeting. Since the election the narrative is that Trump will be good for growth by promoting fiscal stimulus and that there will be some inflation. The 10-year Treasury is up substantially since the election.

Every style of investing and every investment strategy passes in and out of favor. While periods during which a strategy is out of favor can seem like a long cold hard winter, unless investors want to try to time these shifts, the best approach is to stay the course. We acknowledge it is easier said than done. That’s where we attempt to help.

We make an effort to lower the emotional gain, or amplification factor, of the uncertainties that we live with. We try to separate the signal from the noise. To do so we communicate with you and remain responsive to your unique situation and concerns. We review your financial plans, recommit to them, and/or make adjustments when necessary. 

As for investments, we are long term long only investors. We do not try to time markets. However, we raise cash if investment ideas seem scarce, valuations stretched, or there are clearly heightened risks. Cash can help dampen the painful impact of increased volatility or temporary declines in investment values, so that volatility does not become a permanent loss of capital as one is forced to, or feels compelled to, sell out of positions at the wrong time. That is, cash is a practical and emotional bulwark against making rash decisions. In addition, cash provides optionality. Cash allows us to take advantage of downward volatility by buying attractively priced investments. 

There are times when some of the “all other things” that impact investments are positive. The Federal Reserve is signaling that it will raise rates in December, the second time in twelve months, the only time in 2016. But it is fair to say that the increase would be driven by a decent, if not strong, economy—passable GDP growth, good employment numbers, and the best wage growth since the Great Recession. Don’t get us wrong, things are far from rosy. However, the Fed is looking for the opportunity to begin to normalize interest rates and this data seems to support an increase. In general, an increase in interest rates is positive for savers.

Because we don’t time markets the trick for us is to manage cash, correctly size the position of each investment we make, avoid unintended risks, and to invest in companies whose business can benefit from an increase in interest rates and those that can prosper from the improvement in the underlying economy. With regard to yield, we look for companies that can not only maintain dividends, but potentially raise them, either because the economy is positively impacting the business or because a rise in rates does not exert a negative impact on business prospects.


Disclosure


Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Berson & Corrado Investment Advisors, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Berson & Corrado Investment Advisors, LLC.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Berson & Corrado Investment Advisors, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Berson & Corrado Investment Advisors, LLC’s current written disclosure statement discussing our advisory services and fees is available upon request. If you are an Berson & Corrado Investment Advisors, LLC client, please remember to contact Berson & Corrado Investment Advisors, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services.