The Impact of Rising Interest Rates on Bonds

An interest rate hike has been widely anticipated for some time. According to an October survey of 50 top economists conducted by the Wall Street Journal, the yield on the 10-year Treasury was forecasted to rise nearly one percentage point to 3.47% by the end of 2014. What impact would such a rise have on your investment portfolio?

First, Christopher Philips, a senior analyst in Vanguard’s Investment Strategy Group, points out the historical inaccuracy of such forecasts. For instance, a similar survey conducted in 2010 had economists predicting a 4.24% 10-year Treasury yield by the end of the year, an increase from 3.61% at the time of the forecast. In actuality, rates declines to 3.30% at year-end. The inaccuracy of these forecasts is well documented. In fact, as Allen Roth mentioned in the December issue of Financial Planning Magazine, a 2005 study by the University of North Carolina titled “Professional Forecasts of Interest Rates and Exchange Rates” found economists predict future rates far less accurately than a random coin flip would fare as a predictor.

Clearly, we can’t be confident what interest rates will do in 2014, but what if economists are finally correct and rates rise? How damaging would an interest rate increase be for bonds? If interest rates rise one percentage point next year, the intermediate aggregate bond index is expected to lose -2.8% — far from catastrophic. Of course, such potential risk is notably minimal when compared to the downside of owning stocks (remember the -36.93% loss endured by the S&P 500 in 2008?).

It is also interesting to study how bonds have historically performed in periods of rising interest rates. Craig Israelsen, a BYU professor, recently documented how bonds performed during the two most recent periods of rate increases. Israelsen points out that although the federal discount rate rose from 5.46% to 13.42% from 1977 through 1981, the intermediate government/credit index had a 5.63% annualized return during that period. The next period of rising interest rates was from 2002 through 2006, when the federal discount rate had a fivefold increase: from 1.17% to 5.96%. During this period, the intermediate government/credit index obtained a 4.53% annual return. Clearly, even in an environment of rising interest rates, bond performance was surprisingly strong.

Most importantly, investors should never forget the value bonds add to a portfolio as a diversifier to stocks. Frequently, the performance of stocks and bonds are inversely related. For instance, when the stock market suffered during the tech bubble crash of 2000-2002, the Barclays Long-Term Government Bond Index rose 20.28%, 4.34%, and 16.99% in those years, respectively. More recently, when the S&P 500 lost -36.93% in 2008, the Long-Term Government Bond Index rose 22.69% during the year. This diversification benefit may prove useful when stocks ultimately cool off from the extended hot streak they have experienced since 2009.

In 2013, the Aggregate Bond Index decreased in value by -1.98%. Given the occasional negative correlation in performance between stocks and bonds, is it really surprising that bonds didn’t produce a positive return given the incredible year stocks had (S&P 500 up over 32%)? Additionally, held within a diversified portfolio, isn’t the -1.98% return produced by bonds during the recent equity surge a small price to pay for the additional security they are likely to provide when markets reverse?

In summary, it doesn’t seem prudent to avoid bonds entirely during periods of expected interest rate increases. First, forecasts of rising rates are far from certain. Second, even if interest rates rise bonds are still likely to be far less risky than stocks. Third, rising interest rates don’t necessarily mean declining bond values are a certainty – in fact, bonds performed quite well during the past two periods of rate increases. Finally, bonds are a vitally important part of a diversified portfolio, and owning uncorrelated and negatively correlated assets will be critical when equities ultimately lose their momentum.

The Flaws of Unemployment

The Dow Jones Industrial average sits just over 16,500; quite a comeback over the last few years. In fact, just recently the Dow Jones hit its highest mark yet in US history. What is causing the market to rise to new highs? Is this conducive of an economy pulling itself out of a global recession? There is very little evidence to support this market surge. Lets take a closer look as to why our economy is not reflective of this market rally.

Historically, any significant jump in the Dow Jones would signal a strong and healthy economy with all the opportunity in the world. Meaning that there would be little, if any, layoffs and unemployment would be at it lowest levels. Today that is not the case. Common economic indicators, such as the unemployment rate show sluggish results at best; while conveniently painting a picture of unrealistic momentum in the work force.

In order to understand the true numbers of the unemployment rate, it is imperative to understand what each number represents. The Federal Government uses workforce and non workforce percentages of Americans over the age of 16. The workforce numbers represent those who recently had a job and are actively looking for another job, thus being eligible for unemployment benefits. The non workforce population represents those who do not work, had a job, cannot find a job, and have been nonactive in job searching (unemployment benefits being expired). The number of non workforce Americans in April of 2014 was 92 million. Conversely, the number of workforce Americans was 155.421 million in the same month. However, the Federal Government only uses the workforce numbers when calculating the unemployment, excluding the non workforce numbers from the formula. In April, those who are actively looking for a job represented 9.73 million of the workforce. Therefore, the “unemployment rate” in April was 6.3%. However, if you use the relevant non workforce numbers the unemployment rate is much higher; as definably those who have given up looking for a job still do not have one. Additionally, there are many not counted in the unemployment rate that continue to look for a job; simply because they lost their benefits. The question is, why doesn’t the unemployment rate factor those who can work but have given up?

In addition to the skewed numbers of unemployment, when you look at the salaries of those working another unrealistic picture is being painted. Of the 155.421 million working Americans, approximately 40% are making poverty level wages. Furthermore, over 20% of the workforce made more in 2006 than they did in 2013. These percentages of the labor force are not reflective of a market being at its highest levels. Yet here we are with the market rallying at its highest point.

Indicators like the unemployment rate can show counterproductive numbers of growth because of the continuation of the Federal Stimulus. Regardless of how high the Dow Jones has jumped, the Federal Government still feels that $40 billion per month of treasury bond purchases is necessary to sustain today’s unpredictable market. Granted, the Federal Government has dropped these monthly purchases from $85 billion per month to $40 billion; yet still the overall toll of the Federal stimulus is over $4 trillion dollars since the market crash of 2008. The Federal stimulus keeps interest rates low, while keeping a tight leash on inflation. Without the Federal Stimulus, the Dow would not be where it is today. Because of these cash injections, factors like the unemployment rate often speak to the contrary of a rallying market. As we continue with the Federal Stimulus, our long term debt continues to grow. The question is, how long can we sustain this high point in the Market while adding an additional $480 billion to our National deficit this year?

Until we answer that question, indicators such as the unemployment rate will continuously show data non reflective of a healthy economy. Because of conflicting reports like unemployment, many financial firms are predicting a sizable correction of up to 20% coming right around the corner. Bottom line, whichever way you choose to redirect your retirement nest egg, make sure to you understand the unbiased numbers in order to help guide you in the right direction.

Various Benefits and Risks of Timber Investment

Among many other alternative investment options, timber investment gained most popularity throughout the world. Apart from the expert investors, normal people are also investing in timber for various reasons. Unlike other options, timber investment contributes towards the environment and also offers high returns.

Here are the benefits of investing in timber –

High Return

This alternative investment option is famous for its high return. In the past 25 years, timber surpassed almost all other stock markets in terms of returns. Timber offers investors with an average annual return of 15%. There are few other options around the world which are as high yielding as timber.

Protection against Inflation

In the past few years, the world economy experienced inflation at its worst. Numerous people became the victim of inflation. However, with the help of timber investment, a person can secure a great future ahead, which will remain unaffected even during inflation.

No Relation with Other Assets

Stocks and bonds depend on each other. Apart from these two options, almost all other investment options are inter-related, when it comes to the return. However, timber does not depend upon any other assets. Therefore, one can invest in timber with much hassle. On the other hand, people who put their money in some other option, have to keep an eye on many other things, which find the rate of return.

Environmental Benefit

This is the unique benefit of timber investment upon other available options. Timber absorbs the excess carbon in the atmosphere and helps create a natural habitat for animals. Moreover, for each timber tree cut down, forestry experts plant one or more trees in the plantation area. This helps build a greener and better environment for a better future.

This investment process has certain risks, which are quite negligible. They are –

Natural Damages

The forestry experts plant the timber trees throughout a wide area. It is so big that people often think of it as a forest. Natural disasters are quite common in such places. Forest fire breakout, pest attack, sudden storm, soil erosion are some of the most common natural disasters that can damage timber trees. However, in case of any such damage, an investment company replaces the damaged tree with a timber tree of the same age from their own nursery. Moreover, professionals are there in the plantation area to make sure most safety to the trees.

Greater Liquidity Time

This investment option is the best for people looking for a long-term investment. A timber tree takes around 12-15 years to mature. Therefore, the overall investment process takes around 15 years to produce the results. Though one can cut down the trees before the ripe time, it is impossible receiving the projected amount of return in such case.

Timber investment gained huge popularity among normal people, as well as, investors from around the world due to many benefits and low risks. People, who want to make authentic investment, should choose timber investment and take a step ahead towards a great future.