The Rates Of Wrath

This article was originally published on on April 15th, 2014 at 6:30am EST

In the wake of an absolutely stellar performance last year, thus far in 2014 we are hearing a lot about what’s not working for investors, both professional and retail. The major indices have had a rocky go of it, and the recent sell-off in the NASDAQ momentum names (NFLX, TSLA, AMZN, etc.) has pulled the rug out from under many investors. But there are many investments that have been standing out the past few months—some of which are getting adequate attention, and some which aren’t.

After last week’s rout, all the major indices (Dow Jones Industrial Average, S&P500, and NASDAQ) are in negative territory for 2014; bonds are out-performing stocks for the first time since 2011. Almost exactly a year ago year Warren Buffett referred to bonds as “a terrible investment.” And he is almost certainly right, as the rewards for long-term ownership are no longer remotely commensurate with the associated risks.

So what’s an investor to do?

Below is a chart reflecting the year-to-date performance of three separate, interest-rate-sensitive asset classes: Master Limited Partnerships (represented by AMJ), Utilities (represented by IDU), and Equity REITs (represented by VNQ).

While most headlines seem to be encouraging investors to protect their portfolios against the imminence of rising rates, there has been little gained by acting on that advice up to this point. In reality what we have seen is a continuance in the trend of rates moving lower, though not without some turbulence. The chart below shows the 10-year Treasury remains solidly in a downward trend, despite all of the reasons why rates “should” be heading back towards more “normal” levels.

Is it possible that the next 50bps move in the 10-yr Treasury is down, not up? Why not? And if so, what does that mean for the stock market and the asset classes mentioned above?

Let’s take a look at last year’s infamous though all-but-forgotten interest rate spike in May and June. When Bernanke gave the market its first whiff of tapering, the reaction was swift and startling—the 10-yr jumped from 1.90% to 2.50% in five weeks:

In much the same vein, as the 10-yr rate has come off the 3.00% level since New Years’ Eve, REITs, MLPs, Utilities, and Emerging Markets (as represented by VWO) have all found much steadier footing. We outlined some additional bullish points for the emerging markets a couple weeks ago here.

It’s not always easy to stay diversified—to maintain allocations to these interest-rate-sensitive assets seemed a fool’s errand last year. As a result, many investors have missed out on some very nice performance over the past four months.

So how should we be positioned going forward? In my view, what’s worked so far this year is likely to keep working. The chart above demonstrates the 10-yr Treasury being range bound and its current yield sitting at the top end of a current range. Should it fall further from here we are likely to see continued strength in the bond surrogates (AMJ, IDU, VNQ). For taxable accounts, you may wish to consider individual MLPs for the tax advantage—we like AmeriGas Partners (APU), Energy Transfer Partners (ETP), TransMontaigne Partners (TLP), and Williams Partners (WPZ) at their current levels.

Now, the arguments for higher rates make a lot of sense, and shouldn’t be dismissed by any stretch. But I’m not ready to bet with the herd just yet….

Have a great week!

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main
(310) 496-2822 – Fax

Adam Scott’s profile on can be found here.

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