Asad Butt: While I continue to favor the stock market as the top investment vehicle long-term, I am concerned about the pending rise in interest rates and bond yields; of course, higher bond yields translate into a viable option for investors to stash their capital aside from the stock market.
The Federal Reserve has begun the process that will reduce the easy money it has been injecting into the stock market and economy. So far, $30.0 billion in bond purchases each month has been cut, and I expect the remaining $55.0 billion to be eliminated by the year-end.
The end result will be a steady rise in bond yields along the way, which will cause some rotation of capital from the equities market to bonds. We have already seen a big jump in the 10-year bond yield, from about 1.7% in May 2013 to 2.8% as of April 2014. The yields will continue to rise as the Fed reduces its quantitative easing over the year. A move to above the three-percent threshold level will clearly trigger some anxiety among stock investors
The consensus on the Street is for bond yields to rise. The recent auction of $29.0 billion of seven-year notes by the U.S. Department of the Treasury last Thursday yielded 7.317%.
Simply look at the chart below of the 10-Year US Treasury Yield Index from 1990 to 2014.
Chart courtesy of www.StockCharts.com
The first thing you should notice is the rising yields. The chart from 2012 onward reflects the rise in interest rates measured by the bellwether 10-year U.S. Treasury that is surging higher. The yields on U.S. Treasuries have almost doubled since mid-2012.
And with the steady reduction in the Fed’s bond buying, the yields will likely continue to edge higher.
The Fed is also expected to begin to raise interest rates from the current floor of zero to 0.25% sometime in the first few months of 2015. The effect of which will be the central bank needing to increase the yield on U.S. Treasuries to competitively sell the bonds as interest rates move higher.
For the bond issuer, this means the need to increase interest rates to attract buyers.