Lower For Longer: 3 Ways To Combat Low Rates

I wasn’t a very good physics student in high school. I was a writing, reading, and history guy. But I do remember Newton’s Third Law: “For every action, there is an equal and opposite reaction.” The operative word is “opposite”. 

That’s what the bond market experienced last week after the Federal Reserve raised its benchmark Fed Funds rate by 25 basis points, or one quarter of one percent.

If the Fed raises rates, yields are going higher, right? Nope. Newton’s Third Law reared its head and proved itself.

As the Fed announced its intentions, the yield on the 10-Year U.S. Treasury fell. Along with raising the Fed Funds rate, the central bank also articulated its plan to shrink its holdings of government securities. 

During the financial crisis of 2007-2008 as part of its quantitative easing (QE) strategy, the Fed created excess liquidity in the monetary system by buying up U.S. government securities. Their holdings ballooned to nearly $4.5 trillion.

#-ad_banner-#As the economy improved, the Fed first slowed its purchase schedule (the “Taper Tantrum”). Now, the Fed has announced that as its holdings mature, the cash will not be reinvested. This is the Fed’s long game. Rather than increase supply through selling, which would scare the bejeezus out of the market and make everyone head for the hills, the Fed will slowly unwind its positions organically. 

The result will be continued money supply liquidity, which will continue to keep rates low. In other words: More of the same. Accept it. However, here are three things investors can do to operate in an extended low rate environment.

1. Don’t Fight The Fed
Remember the exchange in the movie The Untouchables where Sean Connery’s character tells his boss how to fight in Chicago? “He brings a knife, you bring a gun. He sends one of yours to the hospital, you send one of his to the morgue.” 

That’s how the Fed deals with the markets. One of the worst trades this year is the “rising rates” trade. If you subscribed to this, let go. The Fed is bigger than all of us. They have a mission and are backed by the full faith and credit of the United States. 

2. Make Getting Paid Priority One
Rate suppression punishes savers. That’s because central banks want consumer banks to lend money so consumers will spend it. The byproduct will be a rosier economy and mild inflation. 

At barely 2%, owning 10-Year Treasuries isn’t helping you. Are they safe? Sure. But they’re not risk free. The biggest risk is to your cash flow, or lack thereof. 

Big, blue chip stocks offer 50% more income or better with the prospect of growth in both principal and dividends. General Electric (NYSE: GE) currently yields 3.4%. Warren Buffett favorite Coca Cola (NYSE: KO) yields 3.23%. Another great place to look are closed end funds (CEFs) in the tax-free space. The Blackrock Municipal Income Trust (NYSE: BBF) currently yields 5.86%, free of federal income tax.

3. Avoid Some Rate Sensitive Sectors
After the presidential election, financial sector stocks, primarily banks, rallied on hopes of higher inflation bringing higher rates. Banks do well in rising rate environments in that their profit margins improve when they can charge borrowers higher interest rates. 

Those hopes may be fleeting. Take an opportunity to review your holdings. If you’ve received handsome price appreciation in regional bank stocks, consider locking in gains. 

Utility stocks moved up as well. Rising inflation and higher borrowing costs for power producers warrant higher rates for consumers. The Dow Jones Utilities Index (UTIL) has gained 11.4% year-to-date. Review those stocks to take profits as well.

Risks To Consider: Although the consensus forecast is in the “lower for longer” camp, we live in the age of Black Swans. In our hyper-connected socio-economic world, things can turn on a dime. Stay frosty. 

Action To Take: Those waiting for much higher interest rates may start to feel like the Peanuts character Linus when he was waiting on The Great Pumpkin. Expect the yield on the 10-Year treasury to move in a 35-basis point channel for the near- to mid- term, between 2.15% and 2.5% while the Fed executes its plan. Until then, there’s better income out there. You just have to look for it.

Editor’s Note: On average, a handful of investors quietly make $1,543 a month with this simple, three-step system. Some, like Larry from Washington, will bank six figures this year. To find out what you’re missing, click here NOW…