This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

How income investors can play defense as rates rise

By John Gerard Lewis

bond-interest-rates

Whither post-taper interest rates?

The fact is that nobody knows anything. Quantitative easing will taper off, but some say rates will remain relatively low. Others equate a liquidity reduction with escalating rates. It’ll happen real soon. Or it will happen in June. Or it might happen early in the first quarter. Or maybe in March.

That there is such broad uncertainty about "Life After Taper" isn’t an insignificant matter, because if nobody knows when and to what extent it will occur then some will have guessed right, but everyone else will be surprised — and wrong. Guessing is mere gambling, not investing. And surprised investors become panicked investors who typically make very bad decisions.

Thus, what we know is that it is coming and that nobody knows when. But based on recent history we can proffer some reasonable possibilities.

If interest rates were to rise modestly — say, up to 3.5% for the 10-year Treasury note during 2014 — and then stabilize, we might thereupon expect bond prices to correspondingly dip and then level off for a while. This could delight stock investors who dismiss it as the natural result of an improving economy and corporate profits.

Bond investors would be less enthused, though somewhat relieved that rates didn’t reflexively shoot through the roof. Still, depending on the respective durations of their holdings, bondholders could find themselves merely treading water, at best, due to still low rates. And they’d retain the worry of a painful decline in bond values as, sooner or later, rising rates accompany an improving economy. That could be an interminable, agonizing slog.

Remember, the most recent long-term trend in interest rates lasted three decades. It was an upward trend, but the next secular one will be in the other direction.

Of course, the economy, which has recently shown fits and starts of a possible upturn, could abruptly blast off, spurring the Fed to totally plug the liquidity spigot. Rates might then rise unabated. While unlikely, that scenario is on the table.

But nobody knows. And that is why bond managers, who really have no other choice, are roundly touting their timing skills. While acknowledging the inevitability of tapering, they assure their respective investors that they, and only they, will be able to see the whites of Janet Yellen’s eyes in time to outflank her.

I don’t buy it. They sure didn’t outmaneuver Ben Bernanke last May, and his was a mere head fake. Within days of the chairman’s taper murmurings, bond funds began to sag. Of course, it turned out to be a nonevent, but neither bond rates nor prices have returned to their May levels.

The coming one-way direction of rates makes this a particularly critical moment. There are a lot of Pollyannas out there. I’m a card-carrying Cassandra. Investor sentiment, no doubt influenced by a 30% year-to-date stock market rise, is very high. That is a red flag. Such optimism is normally attended by complacency and an inclination to ignore even highly likely, near-term events.

And the daily apologias, oh my: We’re hearing abstruse distinctions between “tapering” and “tightening,” as if they were discrete elements in a sure mathematical theorem that determines absolute market outcomes. Such semantic gymnastics are surely a warning.

History informs that times such as these aren’t favorable to the complacent. The time to avoid disaster is before it occurs. Now is a time to play defense.

For bond investors, that means it is time to completely eliminate interest-rate risk, even if rates shan’t rise at all for a few months. Why? Because trying to time it is too difficult. Oh, fund managers will tell you they’ll be able to time it right up to the last millisecond. But they can’t.

For purposes of income, it is better to take more credit risk now than rate risk, so I’m OK with (judiciously) going farther out on the yield curve at the expense of credit quality. Besides, any given underlying security’s default risk will soon terminate if you keep your durations short.

Therefore, in both my personal and managed portfolio, I have jettisoned all long-duration fixed-income funds, in favor of low-duration funds like PowerShares Senior Loan Portfolio (BKLN) and Guggenheim BulletShares 2014 High Yield Corporate Bond ETF (BSJE). Both have short overall maturities and yields in the 3%-4% area. I personally continue to believe that is a rewarding way to play defense if rates rise.

Photo Credit: Gamma Man

DISCLAIMER: The investments discussed are held in client accounts as of November 30, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

John Gerard Lewis

John Gerard Lewis

I am John Gerard Lewis, a registered investment adviser representative based in Olathe, KS, and the Founder and President of

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 17,083.80 -2.83 -0.02%
S&P 500 1,987.98 +0.97 0.05%
NASDAQ 4,472.1080 -1.5890 -0.04%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs