Monthly Archives: July 2015

Bonds and Rising Interest Rates

My column in on bond strategies for rising interest rates

3 Great Ways to Protect Your Bond Portfolio

NEW YORK (TheStreet) — If you’d like to protect your bond portfolio from rising interest rates you might consider a bullet. Or you could stay on top of rising rates with a ladder. If you don’t like bullets or ladders, you could work with a barbell to strengthen your portfolio.

Sound crazy? It won’t when you’re done reading this.

Most investors expect the Federal Reserve to start raising its short-term interest rate target, the federal funds rate, this year.

In testimony to Congress, Fed Chair Janet Yellen recently said:

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“As we’ve said all along, we have no judgment at this point about the appropriate date to raise the federal funds rate. Our judgment about that will depend on unfolding economic developments. …  If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target.”

When interest rates rise, bond prices fall. The sensitivity of a bond’s price to changes in rates can be measured by a complex mathematical formula known as the duration. The duration of a bond factors in current yield, yield to maturity, maturity date, call provisionsand other variables. All other factors being equal, bonds with longer maturity dates will be more sensitive to changes in interest rates than bonds with shorter maturities.

We’ve seen a lot of movement in rates over the last 35 years. In 1981 the yield on the benchmark 10-year Treasury note hit an all-time high when it touched 15%. In July 2012 it hit a 200-plus-year low when it was yielding 1.45%. Currently the 10-year yields about 2.35%, so the markethas been pushing rates higher over the last couple of years.

If you’re a fixed-income investor who owns individual bonds rather than bond mutual funds, there are some basic strategies you can be using in an environment of rising rates.

One is the barbell. With a barbell you’ll have half your funds invested in long-term bonds to get some yield and the other half in short-term bonds. The strategy looks like a barbell as it is weighted at the ends with nothing in the middle. As the short-term notes come due they are rolled over into new short-term issues.

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Hedging with Volatility Products

My column in on hedging with volatility products;

How to Protect Your Portfolio From Stock Market Turbulence

NEW YORK (TheStreet) — Volatility in the stock market is what makes investors nervous. Not all volatility is bad, though, for without volatility stock prices would never rise. Volatility is typically measured as the standard deviation of returns for a particular stock or market index. It’s downward volatility of the market that causes fear and panic.

The CBOE Volatility Index, or VIX, is often referred to as the “fear index.” The VIX is calculated from the implied volatility of options on the S&P 500 index. When fear is high, the implied volatility can rise rapidly, causing the value of the VIX to spike.

The VIX has been around since 1993, and according to the CBOE it is considered to be the world’s premier measure of investor sentiment. VIX futures have been trading since 2004, and options were introduced in 2006. The introduction of futures and options on the VIX has given investors a good way to trade volatility and use it as a tool for hedging risk.

Recently, the explosion of exchange-traded funds has led to the creation of several volatility-based ETFs, making trading volatility easier than ever before. According to the ETF Database, there are several different volatility ETFs available today, including short-term, midterm, leveraged and inverse.

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There have been numerous studies done on using the VIX to hedge equity portfolios. Goldman Sachs did one that concluded that VIX options could be a very effective portfolio management tool for risk reduction.

Today with all of the volatility-based ETFs available, investors who want to do some hedging can use an ETF, VIX options or an options strategy with one of the ETFs.

One thing you can do is to simply purchase the ETF and hold it until the VIX increases or the time frame during which you want to hedge your portfolio has passed. Holding the ETF long term may not work as well as you’d like, however. The funds consist of futures contracts that are rolled over as they expire, and there will be some time decay. If the stock market is rising and volatility is falling, the ETF can lose so much value that it will no longer be effective as a hedge over a long period.

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Second Quarter Earnings

My column in the Sierra Sun on Q2 earnings;

Earnings reporting season has just gotten under way. Alcoa was the first company to report, and they opened second quarter earnings on July 8 with a strong report. Corporate earnings are the number one driver of stock prices.

According to FactSet, earnings for S&P 500 companies for the second quarter this year are projected to decline by -4.4 percent.

The last time a year-over-year earnings drop was reported was the third quarter of 2012, and that decline was only -1.0 percent.

This quarter is projected to have the largest drop in year-over-year earnings since the third quarter of 2009, when earnings declined -15.5 percent. So far, only 24 companies have reported and of those 16 have beaten their earnings estimate.

There are several companies poised to report very strong year-over-year earnings growth.

According to an article by Philip Van Doorn in Market Watch, there are some companies that should report growth above 35 percent, and that list includes Apple, Target, General Motors and more.

Apple’s earnings are projected to grow by 39 percent and their sales should grow 30 percent, mostly due to the iPhone.

First Solar leads the list with a projected growth rate of 605 percent, and is followed by News Corp and Adobe Systems with projected earnings growth rates of 474 percent and 271 percent, respectively.

It will be interesting to see how the earnings season plays out this quarter. We’ll get the results over the next few weeks.

The strong US dollar will still have an impact on the earnings of multi-nationals that generate a lot of revenue overseas.

The bar is set pretty low this time with a projected drop of -4.4 percent, so hopefully we’ll see many upside surprises.

I’ll do a follow report when the earnings’ reporting is complete. One thing to watch for is how companies write their press releases — sometimes they are so vague and confusing they can be difficult to decipher.


Bonds and rising interest rates

My column in the Sierra Sun on bonds and rising interest rates.