NEW YORK ( TheStreet) -- With long-term U.S. Treasury yields on the rise, investors need to consider which portions of their portfolios will fare best under long-term and short-term scenarios.
Long-term U.S. Treasury securities were trading at a yield of 1.81% Tuesday morning, with yields as high as 1.91% on Jan. 3, rising from a range of 1.60% only a month earlier. During this painful economic cycle, U.S. Treasury yields briefly went as low as 1.38% in July.
UBS analyst Brian Meredith late on Monday said that his firm's "economics team expects increases in U.S. interest rates (10-year Treasury yields up 60bp in 2013 and again in 2014) and a steepening yield curve." The steepening yield curve would, of course, benefit lenders and would fit in with the Federal Reserve's recent actions.
The central bank in December announced that it would continue its purchases of mortgage-backed securities at a pace of $40 billion a month, and would also continue buying back long-term Treasury securities, "initially at a pace of $45 billion per month," however, the Fed stopped its simultaneous monthly sales of $45 billion in short-term Treasuries, which is likely to have the effect of increasing demand and holding short-term rates down.UBS expects "increases in longer-term U.S. interest rates and a steepening yield curve," forecasting for "year-end 10-year Treasury note yields to rise from 1.8% in 2012 to 2.4% in 2013 and 3.0% in 2014 (as shorter-term Treasury yields remain little changed during the next few years)." "Historically, the stocks in most of the industries within the financial services sector have demonstrated moderately strong, positive correlations with U.S. Treasury yields," Meredith Said. According to UBS's data, with some information provided by FactSet, the S&P 500 (SPX.X) rose 14% from Oct. 19, 2010 through Feb. 8, 2011, when the yield on 10-year Treasury paper rose by 125 basis points and two-year Treasuries saw their yield climb by 49 basis points. Meanwhile, stocks of "ebrokers" -- the group that includes Charles Schwab (SCHW - Get Report) and TD Ameritrade (AMTD - Get Report) -- rose 27% as a group, large-cap commercial banks were up 20%, and several other groups saw double-digit stock price increases, including life insurers, trust banks, and universal banks and brokers, which is the group that includes Bank of America (BAC), JPMorgan Chase (JPM), Citigroup (C) and Morgan Stanley (MS - Get Report).
What If Short-Term Rates Rise?
The "ebrokers are most levered to higher short-term rates as much of the client cash is invested relatively short term," Meredith said. "With average durations of ~2 years, longer-term rates will also have an impact as the portfolio rolls over. We estimate that a 200bps rise in the Fed funds rate would increase SCHW's earnings by about 115%. The impact for AMTD is somewhat lower at 45%."