How The Market Is Impacted By The Rising Interest Rates?

When the interest rates have been trending lower, U.S. stock markets have been making strong gains.

The 10- year U.S. Treasury yield was yielding more than 3% in November 2018 but fell to 0.52% in August 2020, and was trading at 0.75% at the time of this writing.

Market practitioners of the stock market use the phrase “TINA,” which is an acronym for “there is no alternative.” 

Trying to earn yield from a fixed-income instrument has become increasingly challenging demanding some investors to accept either greater credit risk, such as high yield bonds, or longer duration. 

To an investor, a longer duration means you do not get all your money back until a later date, which may not be desirable.

Although U.S. Treasury bonds offer a limited yield, as mentioned by the 0.75% in the 10-year U.S. Treasury last month, there is a degree of safety in the return of capital with the federal government issuing the bonds.

High-yield bonds typically invest in companies with lesser fundamentals, which don’t have the government guarantee attached. 

For example, the SPDR Bloomberg Barclays High Yield Bond ETF (ticker: JNK) has more than 99% of its fund invested in bonds. Fidelity shows 99.6% of bonds have a credit rating of high-yield.

One of the best performing sectors this year has been that of homebuilders. As represented by the iShares U.S. Home Construction ETF (ITB), the sector is up nearly 36% this year. 

Of note, this ETF was up around 39% last year and roughly 50% in 2017.

Not all real estate investments have performed well. The Real Estate Select Sector SPDR ETF, XLRE is showing a loss this year by comparison.

Certainly, low mortgage rates are benefiting the homebuilding sector. Over the past two years, the 30-year fixed mortgage rate has fallen by over 2%. 

The savings from lower mortgage rates is often reflected in discretionary spending.

In spite of the economic turbulence the sales have increased 5.4% in the last 12 months and in conjunction with it the performance of Consumer Discretionary Select Sector SPDR ETF (XLY), is up by 24% year-to-date and increased by more than 28% in 2019.

The U.S. 10-year Treasury rate hit 0.52% in July, but it has rebounded, and by the end of September it had climbed near 0.7%. 

The move up to 0.7% may not sound like much, but know this, markets are forward-looking and do not wait for confirmation to make price adjustments.

Projecting to next year, if the economy picks up and the health crisis has waned, what is the likelihood that the 10-year U.S. Treasury yield will remain below 1%?

In the fourth quarter of 2018, when the Federal Reserve was still hiking its federal fund rate, the stock market suffered a correction, with value stocks outperforming growth stocks.

Interest rates are near historically low levels. They are so low that any rise in rates will almost be hard to notice by the average investor. 

Interest rates may have only inched higher, but if a trend results, portfolios may need to be repositioned.