How to profit from the shift to rising rates
MarketWatch Databased News - April 1, 2010
LA JOLLA, Calif. (MarketWatch) -- Investing in an increasing interest rate environment has not been as scary as most people would have you believe.
In fact, since the Target Rate began to be widely accepted in 1997 the market has performed very well through tightening cycles.
Conversely, it has not begun to decline again until an easing cycle began (see image). This has been true regardless of the economic conditions during the tightening cycles, but the purpose of a change in policy has also always been due to economic changes, so there is an obvious relationship.
Therefore, the cusp of a change in policy from tightening to easing reflected an observed weakening in economic conditions, therefore the declines. Conceptually, since 1997, the purpose of tightening was to throttle a growing economy. That has always been true, until now.
When the next tightening cycle begins, it will not be to throttle an economy that is growing too fast. Instead, it will be to rebalance rates to more reasonable levels. The Economy may be less vulnerable when they begin to tighten, but it will not be too strong. That is a material difference, and the correlation between higher rates and higher market levels witnessed since 1997 will be in jeopardy as a result. I expect that correlation to break.
When interest rates begin to increase next time, I expect the economy and the stock market to experience a sustained negative reaction. Instead of the knee jerk negative reaction most have been used to, the opposite may happen instead. Since 1997, the knee jerk down on the heels of a rate hike has been followed by a sustained move higher. This time, the knee jerk could be up, followed by a sustained move lower.
Initially, Wall Street may consider a rate hike as a sign of confidence. Soon afterwards, they will realize that it is much more of a burden. Soon after the next tightening cycle begins, expect the correlations referenced above to break, and expect the economy to come under pressure.
Translated into market terms, I expect the market to begin to weaken soon after the first round of rate hikes, and then I expect it to get worse. There are a few ways to play this.
First, we have been in long positions since February, well before the rebound gained momentum. We are holding a defensive portfolio, but one that is working exactly as it should. The positions include: ProShares UltraShort 20+ Year Treasury ETF , ProShares Ultra Gold ETF , ProShares Ultra Oil & Gas ETF, ProShares Ultra Financials ETF.
These ETFs were specially chosen to take advantage of the move higher we expected, and which we expect to continue for the time being. These were defensive and some of these positions could work even if the Market falls.
Now, we have sell targets in place, and we will sell some of those long positions and convert to positions geared to take advantage of downside market moves when our targets are hit. The candidates for the short side are ProShares UltraShort QQQ ; ProShares UltraShort Dow30 ; ProShares UltraShort Financials ; and ProShares UltraShort Russell 2000 ETF.
In summary, I expect the next tightening cycle to define a material change in historical correlations, and I expect the fears that many market pundits associate with higher rates, fears that have been unfound since 1997, to become reality. Everyone should be concerned with higher rates because higher rates will have a material negative impact on this economy.
These recommendations may have already been disseminated to subscribers of Stock Traders Daily.
Thomas Kee is president and chief executive of Stock Traders Daily and the author of "Buy and Hold is Dead: How to Make |
