What Happens To Large Caps When The 10 Year Rises? [Schlumberger Limited., Caterpillar Inc., Walt Disney Company]

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June 23, 2014 2:25pm ETF BASIC NEWS

raises-questionsOver the past 50 years, the average yield on the 10-year Treasury has been 6.6%. We hit 2.42% in the last few weeks, and that means there is plenty of room to move way up. There has been a lot of talk about what will happen to Treasury bonds when interest rates move up, but very

little talk about the effect an unavoidable increase in interest rates will have on stocks.

As with bonds, there will be some stocks that will do better than others. Namely, companies with modest dividends and the potential for fast growth. History tells us these outperform in an increasing rate market.

A study of past periods when the 10-year Treasury’s yield has increased by a half of a percentage point showed large cap stocks with modest dividends and growth potential returned an average of 20% in the 12 months following the increase.

Companies like Schlumberger Limited.(NYSE:SLB), Caterpillar Inc.(NYSE:CAT) and The Walt Disney Company(NYSE:DIS).

Schlumberger has a puny 1.5% dividend and an 18% five-year growth estimate.

Disney yields 1% and is estimated to grow 16% per year.

And Caterpillar, the highest of the payers, has a 2.2% yield with a 12% growth estimate for the next five years.

When rates finally move, it will be a whole new ball game for stocks and bonds. Make the necessary changes before the horse gets out of the barn.

It’s Not Different

As long as we are on interest rates, here’s one that will really pop your cork.

Spain is paying less to borrow money than the USA.

Yup! You heard me right.

Right now the benchmark 10-year Treasury in the U.S. pays around 2.6% to about 2.8%, and has been in that range since January.

The Spanish 10-year is paying 2.57%. Is Spain really a better credit risk than the U.S.? No! Spain is benefiting from European Central Bank (ECB) easing and no inflation in sight.

But the longer the Fed goes without raising rates, the stronger the economy gets and the greater the chance of real inflation. In that case we will see much higher 10-year yields, and the spread between our borrowing rate and Spain’s will be much higher.

In case you’re wondering, none of this makes sense. We are in one of the most confusing bond markets of my 30-year career, and it doesn’t look to be improving anytime soon.

The EU is pouring money into Treasurys, which is helping to keep rates low, while our own Fed is tapering bond buying and talking rate increases.

Talk about pushing a rope!

But, no matter how upside-down this may seem, it is very foolish to think the Fed will not act and keep rates low indefinitely. It will not, and that is the only definite in this whole mess.

Remember, the markets, bond and stock, will always correct. The longer it takes, the bigger and more exaggerated the correction will be. In the case of bonds, that means to hold only super-short maturities in both individual bonds and especially bond funds.

The old adage “It is different this time” will always come back to bite you on the backside, especially in this market. It is not different and this will resolve itself.

The “Slap in the Face” Award, Italian Style

And finally, the real reason anyone watches this segment… the “Slap in the Face” Award.

This week might be the best “Slap in the Face” Award ever. It may not be the funniest, but it will definitely sting for some time to come.

I’m not sure who the winner is: the EU, Italy, or hookers, pushers and smugglers.

So here it is…

It seems the Italian government, in an effort to boost a chronically weak GDP, will now include in its GDP calculations revenues from prostitution and illegal drug sales.

Oh, and smuggling, too!

This proposal is not coming from a splinter group or a lobbying group for hookers. Nope, it is from the prime minister himself. His thinking is if they get their chronically stagnant economy above $2.1 trillion, he can spend more money.

The EU has restrictions on how large the spread can be between spending and a budget deficit. So, boost the GDP with revenues from hookers, smugglers and dope, and spend more.

Have we really sunk this low?

If these are truly under-the-radar, illegal operations, how do you measure them? Do you now require criminals to submit quarterly reports? That should be interesting.

Can you see the CNBC team anxiously waiting for the heroin numbers to come out?

God, I hope Obama doesn’t get wind of this. I’m afraid to think of what a taxer and spender like him could do with this kind of thinking.

Let see… car thefts, burglaries, chop shops, murder for hire. Now we’re talking revenues, American style!

The sky could be the limit on this one.

by Steve McDonald, Bond Strategist

Investment U provides cutting-edge research and strategic financial recommendations for all levels of investors through its morning publication Investment U Daily and its related publications.

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