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It's commonly held wisdom that stock markets go to heck in a hand basket when interest rates rise. So, the thinking goes, you'd be better off selling ahead of time before that happens.
No doubt it's tempting to head for the hills with rates at historical lows, but it pays to do your research before you hit the "sell" button.
The three companies I'm going to show you today, for example, can actually benefit from rising rates.
First, let's take an "Econ 101" look at the impact interest rates can have on stocks, especially when rates start rising…
How This Urban Legend Got Started
Like most urban legends, there's a grain of truth when it comes to interest rates and your money. That's because interest rates are quite literally a reflection of the time value of money. When rates are rising, the cost of borrowing goes up. When rates are falling, money gets cheaper.
Economic theory tells us that more expensive money decreases the amount of money in circulation because customers tighten up while cheaper money increases the amount of money at work. That's why the Fed, which subscribes to this theory, has kept rates so low for so long. Team Bernanke and now Team Yellen want to ensure there's money available and, by implication, that people borrow enough to keep it moving and the economy in recovery mode.
Practically speaking, you see this in everything from credit card statements to home mortgages. As rates rise, the propensity to borrow declines and there's less discretionary money spent. But as they fall, consumers head out to spend based in good part on borrowing that has "stimulated" the system. Personally, I think it's a sad state of affairs that debt has become so critical to our way of life, but that's really a story for another time.
What you need to know today is how the relationship I've just described impacts stock prices.
Companies are valued based on earnings. And earnings, in turn, are a function of the time value of money associated with all future cash flows. Loosely speaking, therefore, the more a company earns, the higher the expected stock price is ahead.
Theoretically, if rates rise that means money is getting more expensive so the cost of debt rises and revenue from customers drops. Earnings then take a nose dive and, not surprisingly, so do stock prices which, in turn, makes stock ownership less desirable.
Here's where it gets sticky.
By stimulating the economy and keeping rates so low for so long at the same time, the Fed is clearly fanning inflationary embers while seemingly acting to keep rates low. Every dollar the Fed kicks into the system diminishes the value of every other dollar already out there.
Ultimately rates will have to rise to compensate for the lost value, goes the argument for millions of investors.
Take Winners on the Overlooked Rising Rate Bounce
But here's the thing. You don't just immediately jump from a slight increase in "Treasury yields that's barely noticeable on a ten-year chart to hyperinflation even when it's the worry du jour," according to Jim Cramer in his book Getting Back To Even.
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About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean, and he's also the founding editor of Straight Line Profits, a service devoted to revealing the "dark side" of Wall Street... In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.
ZIRP
WAR STOCKS, ANYONE ?
I look forward to the day, probably not far off, when China decides to take back its rightful ownership of the contested Senkaku Islands off the Coast of Taiwan. They know President Obama won't deter aggression ( Syria, Ukraine, etc.). Japan will either have to acquiesce to Chinese territorial demands, or suffer. Japanese like to suffer. China suffered in the 1930's, so its Karma Time again. Which defense stocks would profit most when a South China Sea conflict arises in the next few years. It will.
Interesting. But the numbers are pretty spread out. Time of increasing short term interest rates goes from 5 months to 3.5 years. The increase in these rates spreads from 19% to over 400%. Though rising interest rates certainly have huge effects on the markets, just how much and when? There are also other factors to consider. Some being margin debt as percentage of gdp, volatility readings, a stock's intrisic value versus its traded value ( are there too many over priced stocks ), in order to see a strong downturn coming in advance.
FAST AND FURIOUS
Well, its not just the CIA running guns to Mexican Cartels anymore. Nope. Bear markets these days are all highly correlated, meaning when markets suddenly decide to decline, they all get the idea at the same time. Moreover, down markets often go down much faster than they went up.
So, different sectors do well at somewhat different parts of a bull stock market cycle. However, when the trend changes to negative, they all fall down. So, please don't kid yourself that you will ever "see it coming" next time. You probably won't and even if you did, you can not outgun a panic or swim away from a Tsunami. You have to be somewhat defensive all the time and hedge with stops.
If you don't like trailing stops, consider using options or a specialized inverse fund to protect your money and take the sting out of any short-term market movements that catch others by surprise
Can you explain the 'specialized inverse fund'?
There are any number of ETF's that play the short side of the market like PSQ, SH, MZZ and SDOW to name just a few. Be aware though, that they may not perform exactly as an inverse play on the direction of the market. Look up "inverse ETF problem" for more info.
Flying at 65 000 feet on two propellers?