No one, and I mean no one, has the ability to consume Wall Street quite like Ben Bernanke. After an upbeat U.S. jobs report, interest in the bearded Fed Chairman has reached a fever pitch.
Now, more than ever, Wall Street is telling us that they’re sure the end of “QE-infinity” is coming soon. Some experts are even saying that Benanke’s Fed may taper its bond buying program by summer’s end.
Here are a few investments that will be affected by rate increases, and what you should do next.
Treasuries: the worst investment in the market today
It’s no surprise that a rise in interest rates will obliterate prices on existing bonds. If you’re new to bond investing, put simply, bond prices and interest rates move in opposite directions. This is actually really simple to understand if you follow this simple example; if you owned a bond with a 4% yield it would become less valuable when other, similar, bonds issue 5%.
Simple right? It all makes sense. What doesn’t make sense is why high yield (junk) bond
funds have been hit harder than treasuries. For instance, Pimco High Income Fund (NYSE:PHK)
has been obliterated as Bernanke has warned against the dangers of “yield-chasing” investors, does this make any sense? At the same time iShares Barclays U.S. Treasury Bond fund
has only dropped $1 per share.
Quite baffling, indeed.
When you take into account that the GOVT treasury fund’s yield of 1.05% also gets expenses of 0.15% taken out, you only have an absolute return of 0.9%. Is that really worth it? I’d rather chase the yield of a Pimco High Income Fund (NYSE:PHK), at least you know that when the shares drop you have some yield to keep you whole.
As crazy as it may sound, I honestly feel that if you are going to be in bond, a junk bond fund could be the way to go. The high yields make up for price risks due to interest rate decreases, and the wide diversification guards against the essential risky nature of junk bonds, and defaults.
MBS REIT’s: dangerous ground
What can you say about Chimera Investment Corporation (NYSE:CIM)
and Annaly Capital Management, Inc. (NYSE:NLY)
. No, I mean it, does anyone really, really understand these businesses?
I won’t claim to know these shadowy REIT’s better than you, but I do know a few things about each.
1. Annaly Capital Management, Inc. (NYSE:NLY)
and Chimera Investment Corporation (NYSE:CIM)
are not traditional REIT’s. Both companies are from the same management tree and they specialize in mortgages, not properties. These investment trusts do not originate mortgages however, rather they invest in and manage agency mortgage-backed securities
2. Both of these investments have returned a remarkable amount of cash to their investors and management deserves a tremendous amount of praise for that. Even today, Annaly Capital Management, Inc. (NYSE:NLY) pays a whopping annual dividend yield over 13% and Chimera Investment Corporation (NYSE:CIM) pays out 12%. That’s a bit of a mirage, however, as the dividends have been shrinking in recent quarters.
3. Both Chimera Investment Corporation (NYSE:CIM) and Annaly Capital Management, Inc. (NYSE:NLY) have struggled with rising interest rates and will continue to do so.
In recent years Chimera Investment Corporation (NYSE:CIM) and Annaly Capital Management, Inc. (NYSE:NLY)’s management teams have pulled the ultimate Houdini act, they’ve raised capital and turned it into more capital for shareholders. While they deserve some praise for the past, the future is much more questionable.
The reason things look shaky now is that, as interest rates rise, the cost of the capital they raise will go up as will the number of pre-payments. When Annaly Capital Management, Inc. (NYSE:NLY)’s costs get higher, and the interest on their investments stays neutral, bad things can happen. This will likely crimp margins, and dividends, significantly and it’s the primary reason that both Citi
and Sterne Agee
cut price targets on Annaly recently.
Now, considering how far shares of both Annaly and Chimera Investment Corporation (NYSE:CIM) have fallen already, at some point the prices should bottom. But that bottom won’t come until rates stabilize, I feel you’d be best served to wait and see how what happens with rates before investing in these names.