Zacks Investment Research | May 16, 2018 01:50AM ET
One thing has been more or less constant this year, i.e., rising rate concerns. Higher inflationary expectations and upbeat economic growth have already driven the benchmark treasury yields to 3% that went on to score even higher on May 15 to touch the highest level in seven years at 3.08%.
A strong retail sales report led to the recent spike in bond yields. Plus, San Francisco Fed President John Williams’ comment that he sees three or four rate hikes in 2018 as the "right direction" drove bond yields.
Also, trade tensions between the United States and China is remain. If the countries fail to come to a pact, a member of the ECB’s governing council recently commented that the conclusion of its asset purchases is imminent.
A senior U.S. economist for Capital Economics believes that the ongoing 54% chance of three more U.S. rate hikes this year. Notable, the Fed enacted a 25-bp hike in March.
Rising yields will cause selloffs in both equity and bond markets. SPDR S&P 500 ETF (NYSE:SPY) (AX:SPY) (down 0.7%), SPDR Dow Jones Industrial Average ETF (V:DIA) (down 0.8%), PowerShares QQQ ETF QQQ (down 1.1%) and iShares 20+ Year Treasury Bond (NASDAQ:TLT) ETF (V:TLT) (down more than 1.1%) — all lost value on May 15.
Given this, investors should be interested in knowing the ETF strategies to tide over an abrupt pickup in benchmark interest rates. We have highlighted a few investing tricks for such investors.
Bet on Banks
Financial stocks are direct beneficiaries of a rise in long-term bond yields or steepening in the yield curve, which is the case now. Since banks borrow money at short-term rates and lend the capital at long-term rates, the latest spike in long-term bond yields bode well for bank ETFs.
So, ETFs like KBW Regional Banking Portfolio (NYSE:KB) , SPDR S&P Regional Banking (MX:KRE) ETF (CO:KRE) , S&P Bank ETF SPDR (NYSE:KB) E) and Nasdaq Bank ETF FT FTXO should be on one’s radar right now.
Go Short on Rate-Sensitive Sectors
Needless to say, sectors that perform well in a low interest rate environment and offer higher yield may weaken when rates rise. Since real estate and utilities are such sectors, it is better to go for inverse REIT or utility ETFs. ProShares UltraShort Real Estate (AX:SRS) , ProShares Short Real Estate Rate Hike Bet Put These Inverse Sector ETFs in Focus ).
Look Out for Floating Rate Bonds
Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of the issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. iShares Floating Rate Bond Hedge Rising Rates with Floating Rate ETFs ).
Hoard Up on Inverse Bond ETFs
Shorting U.S. treasuries are also a great option in such times. Barclays (LON:BARC) Inverse US Treasury Aggregate ETN (CM:TAPR) , Ultrapro Short 20+ Year Treasury ProShares DTYS are some of the trusted bets right now.
Target Negative Duration Bonds
Negative duration bond ETFs offer exposure to traditional bonds while at the same time short Treasury bonds using derivatives such as interest-rate swaps, interest-rate options and Treasury futures to lower interest rate risk. WisdomTree Barclays Negative Duration U.S. Aggregate Bond Fund HYND are examples of such funds.
Play Private Equity ETFs
As bond yields have started to rise, investors now need to focus on stable bets that offer way higher than the benchmark yield. For this, the private equity ETF pack is an option.
Investors should note that this asset class is high dividend paying in nature. PowerShares Global Listed Private Equity ETF (HN:PSP) yields about 11.83% annually. Private equity has a low correlation to the broader market.
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