The 10-year benchmark U.S. Treasury yield spiked to 3% on Apr 24 for the first time since January 2014, thanks to dual prospects of a flurry of new government debt and faster Fed rate hikes.
The Fed enacted a 25-bp hike in March, and two more are likely in June and September. But the fed funds futures market lately signaled a 50% chance of one more move in December.
This along with higher inflationary expectations emanating mainly from a crude rally hinted at an end to the low interest rates era in America. Several U.S. economic readings also came in better lately.
Bond market expert Jeffrey Gundlach at DoubleLine Capital and Scott Minerd at Guggenheim Partners noted thatthe 3% 10-year yield is a crucial threshold for the bond market. The benchmark yield only topped this level briefly in 2013 and January 2014.
Rising yields will cause selloffs in both equity and bond markets. SPDR S&P 500 ETF (SPY - Free Report) (down 1.4%), SPDR Dow Jones Industrial Average ETF (DIA - Free Report) (down 1.7%), PowerShares QQQ ETF (QQQ - Free Report) (down 2.1%) and iShares 20+ Year Treasury Bond ETF (TLT - Free Report) (down 0.5%) – all lost on Apr 24.
Given this, investors must be interested in finding out all possible strategies to weather a sudden jump in the benchmark interest rates. For them, below we highlighted a few investing tricks that could gift investors with gains in a rising rate environment.
Tap Regional Banks
Financial stocks are the direct beneficiaries of a rise in long-term bond yields. This time too, there is no exception. In this regard, we choose regional bank ETFs like SPDR S&P Regional Banking ETF (KRE - Free Report) as these have a tilt toward smaller-cap stocks and are mainly focused on the U.S. economy. Since banks borrow money at short-term rates and lend the capital at long-term rates, the latest spike in long-term bond yields bode well for these ETFs (read: Financial ETFs in Focus on Rising Rates Buzz).
Play Private Equity ETFs
As bond yields have started to rise, investors now need to focus on stable bets that offer way higher than the benchmark yield. For this, the private equity ETF pack is an option.
Investors should note that this asset class is high dividend paying in nature. PowerShares Global Listed Private Equity ETF (PSP - Free Report) yields about 11.89% annually. Private equity has a low correlation to the broader market but might underperform severely in the global meltdown, which is not the case presently.
Still Want Bond Exposure? Look at These ETFs
Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of the issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds (read: Hedge Rising Rates with Floating Rate ETFs).
Unlike fixed coupon bonds, these do not lose value when rates go up, making the notes ideal for protecting investors against capital erosion in a rising rate environment. iShares Floating Rate Bond (FLOT - Free Report) is a good bet in this context (read: FLOT vs. FLRN: The Best Floating Rate ETF).
Another option in this space is to tap bank loan ETFs like Highland/iBoxx Senior Loan ETF (SNLN - Free Report) (yields about 4.61%). Senior loans, also known as leveraged loans, are private debt instruments issued by a bank and syndicated by a group of banks or institutional investors. These provide capital to companies that have below-investment grade credit ratings. In order to compensate for this high risk, senior loans usually pay higher yields (read: 5 ETF Ways Bond Bears Must Try in 2018).
Plus, shorting U.S. treasuries is also a great option in this type of an environment. Direxion Daily 20+ Year Treasury Bear 3X Shares (TMV - Free Report) gained about 1.6% on Apr 24 (read: 4 Inverse Bond ETFs to Watch as Rates Rise).
EM Bonds: A Good Bond Pick Too?
Since emerging markets (EM) are vulnerable to rising yields in the United States, one may want to dump this segment. But one should note that the EM segment is pretty solid at the current level as opposed to the developed world. As several EMs have a relatively lower date-to-GDP ratio and offer higher yields, investors can take a look at EM bond ETFs (read: Are EM ETFs the New Definition of Developed Market Investing?).
Though local currency bond ETFs like WisdomTree Emerging Markets Local Debt ETF (ELD - Free Report) (yields 4.95% annually) have been outperforming lately, investors might think about a currency-hedged EM ETF at this moment given the renewed strength in dollar. iShares JPMorgan USD Emerg Markets Bond ETF (EMB - Free Report) (yields 4.49% annually) can be a decent pick for those who look to be invested in the currency-hedged EM bond ETF pack (read: 5 Reasons to Invest in Emerging Market Bond ETFs).
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