Don’t Worry Investors, Everything’s Going to be Alright
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In the later part of the June 19 trading day, the markets adversely reacted to the Fed minutes, which stated plainly that if the economy continues to grow at the pace it currently is there should be a tightening of monetary policy going forward. Many investors, including hedge funds, mutual funds, and traders, have gotten used to the environment of “easy money” through the feeding tube of low interest rates.
Since 2008, many conservative stocks have become expensive because of the fact that dividend-paying equities were offering a return premium against alternative investments such as Treasuries and savings accounts. In other words, the last five years epitomized the phrase “It pays to play.”
Because of this appetite to move money into dividend-addled equities, the S&P rose over 12.7% in the first four months of this year, and added an additional 3.5% in May. The SPDR S&P Dividend exchange-traded fund yielded 16.4% through the first four months and remained relatively flat through May. One should not overlook the fact that although these higher quality stocks have shown considerable gains so far this year, when interest rates eventually do rise, there will be a flight from “risk-on” trades to alternative income-yielding securities, such as corporate bonds.
History likes to repeat itself
Jason Zweig of the Wall Street Journal writes, “History shows that whatever is stretched [the S&P] tends to tear when interest rates rise.” As a matter of fact, in 1994, the Fed began interest rate hikes, and on the first announcement of rising rates, the Dow plunged 2.4%. Does this sound familiar?
That year, the Dow Jones Industrial Average ended up earning a paltry 1.3%, but specific industry equity assets, such as utility stocks, emerging market stocks, and even gold, took significant losses. Dividend-paying stocks took an ex-dividend loss of 6.4% in 1994, so the red flags are waving high right now as the Fed is getting ready to repeat its 1994 actions here in 2013.
Position your portfolios for interest rate hikes
Just because the broader markets generally do not like the first round of interest rate hikes, understand what the micro implications are. First, your 10-year Treasuries would likely lose over 7% over the first 1% increase in interest rates. So to lean on more convertible bonds and high-yield notes would be wise as they are more resistant to interest rate hikes.
Secondly, as Kopin Tan writes in Barron’s, “Among stocks, a one-point rise in long rates could translate into gains…” Note in 1994, with five rate hikes, the Dow Jones ended in the black by 1.3% for the year. Some sectors, namely utilities, lost plenty, but many survived. Historically, with every 1% increase in interest rates, materials, technology, energy, and consumer discretionary all net gains on average of 1.5%.
Lastly, our equity markets and the U.S. currency have been rising together for the first time since 2002. Mr. Tan points out again that, “Technology, financials, and industrials have tended to outperform when stocks and the buck ascend in unison.”
So here we have what our portfolios should be represented by: technology and industrials, coupled with a lean towards high-yielding bonds and/or convertible debt.
What stocks we should be buying now, before the rates start moving.
Maxim Integrated Products (NASDAQ: MXIM) is a favored stock by many, including JP Morgan, which has this on their buy list. There’s no secret as to why we would want to buy this stock--it has a dividend yield of 3.5% and is trading just four points off of its 52-week low.
This integrated circuits manufacturer has a global footprint and is estimated to bring in over $2.5 billion in revenue for 2013, which would be a 50% increase from 2009. Analysts expect this company to continue to expand at a rate of 7%-9% year-over-year, which means your investment should grow along with it. The average analyst has this stock pegged at $33 per share, and if we can add it the rising market premium on interest rate hikes, this stock should trade above $35 by years end. At the current price of around $27 per share, there is much more upside than downside here.
ActiveCare (NASDAQOTCBB: ACAR) is a fierce competitor in the patient monitoring and medical data fields. With healthcare and healthcare information technology a hot topic around Wall Street and Washington D.C., there should be no doubt any portfolio should be represented by this company and its peers.
Their explosive bottom line has seen increases capable of making any investor happy. Additionally, they have been able to commoditize the one overlooked aspect of healthcare records: real-time data, which translates into cost-cutting and profits for their customers—major insurance carriers and self-insured organizations. Last quarter, they reported gross revenues of $4 million, up from $180,000 year-over-year. The stock is treading at 40% off of its 52-week low. Major analysts are beginning to look into this business as they have been competing with device makers like Alere(NYSE: ALR) which is trying to commoditize patient data like ActiveCare has. Michael Tu, an analyst for BlueHill Strategic Relations notes, “ActiveCare has found a leg-in against the giants of Honeywell and GE.”
TrustCo Bank (NASDAQ: TRST) is certainly a buy in this marketplace. It isn’t a secret that banks fair well when interest rates rise. Because of higher rates, banks typically can make money on the burgeoning credit spreads on their products. With the rise in the real estate markets, the activity on a banks commercial and home mortgage portfolios should reflect the new home and commercial purchases.
This particular bank has such growth in mortgage loan activity. They have seen increases in mortgage activity, and welcome over 3% yield spreads, even with these low rates currently in place. As rates rise, variable rate loans issued would be advantageous to the loan holder by demanding higher rates versus an artificially deflated interest rate. With over 70% of its loan portfolio in these assets, rest assured that TrustCo Bank will capitalize on two fronts: real estate and rising interest rates.
Proshares Ultra-Short Treasury (NYSEMKT: PST) is an incredible hedge against rising inflation rates, and is a must-have in your investment portfolio for one big reason: when interest rates rise, bond prices fall. Simply put, as the Fed increases the rates over a period of time, this exchange-traded fund should mete out gains.
This particular exchange-traded fund invests in the fixed income markets of U.S. Treasuries. It primarily invests in treasury securities rated investment grade, which have a remaining maturity of 7-10 years. The fund uses swap agreements and futures contracts to create its portfolio. It also invests some part of its portfolio in money market instruments. The fund seeks to track twice (200%) the inverse (opposite) of the daily performance of the Barclays U.S. 7-10 Year Treasury Bond Index.
Don’t look at the red tickers flying across the screen on CNBC, and please, don’t start grabbing the Prozac and Jack Daniels. Like the title of this article says, everything's going to be alright. In an up-market, down-market, even a flat market, there are always opportunities to protect your wealth and grow it as well.
With the stocks above, I’ll be enjoying an easy ride into the end of the quantitative easing express, and so should you. Whatever the pace that Mr. Bernake decides with his cohorts to raise the Fed Funds Rate, rest assured your investments are safe with these companies and one smart exchange-traded fund.
The Motley Fool's chief investment officer has selected his No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.
Michael Mandala has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!