TAKING STOCK: Interest rates

Dear Mr. Berko:

In February of 2009, I wrote you for advice on how to invest $60,000 for safety and appreciation, and you told me to invest $6,000 each in AFLAC, United Health, Toyota, Federal Express, Panera Bread, Chevron, Boeing, Chubb, Eli Lilly and Bank of America. My $60,000 is now worth $173,000 thanks to your recommendations. Now that interest rates are increasing, what do you think will happen to the prices of the 10 stocks you had me buy? Should I hold them or sell them?

-BE: Destin, Fla.

Dear BE:

You have me confused with someone else. I'd like to take credit for those recommendations; however, I'm "posilutely" certain those issues were not on my 2009 buy list. I've never recommended Boeing, Chubb, Panera, Bank of America, Chevron or Toyota. However I don't know enough about you (age, risk tolerance, other investments, obligations, income, etc.) to provide suitable personal advice. Those 10 are excellent long-term investments that will rise and fall with the market. So if you're a long-term investor, keep them. I think Janet Yellen wasted a bullet when she raised rates in December.

The biblical tale of Joseph in Genesis relates the story and interpretation of Pharaoh's dream. Pharaoh dreamt that seven fine and fat cows came out of the river and fed in the meadow. Then seven ugly and gaunt cows came out of the river after them and ate the seven fine-looking fat cows. So Joseph was brought from the dungeon to interpret the dream. He told Pharaoh the seven good cows represented seven years of plenty and abundance while the seven ugly cows meant that seven years of famine would follow. And the years of famine will be so bad that the good years would be forgotten. Certainly, you know the rest of the story.

Well, we've had seven good years of near-zero interest rates that were the precursor to three-fold increase in the S&P 500 averages between March of 2009 and today. Now we may have seven bad years of higher rates and a declining S&P, and not because it's time to raise rates. Rather because Yellen's incessant quacking and yacking about her intent to raise rates sidetracked her into a tangent, now she's has to do something or look foolish.

According to market analysts, near-zero rates on Treasuries forced staggering numbers of income investors to overweight their portfolios with a superfluity of high dividend stocks and junk bonds. Overweighting portfolios with lower-rated income investments was the lesser of two evils: Investors either prayed daily to their god that the returns they needed to avoid outliving their money would continue or they reduced their standard of living. Unfortunately, overallocation in lower-quality, higher yielding investments became the portfolio of choice. And with Treasuries yielding 2.3 percent, the enormous demand for high-dividend stocks and junk debt kept valuations unnaturally high, even as corporate earnings began to wane.

Now the crutch of the matter is, if Yellen continues raising rates, then those overallocated, low-rated, high-income investments will become an albatross on investors' sore backs, and everyone whose ox was gored will be squealing. If Yellen continues to raise rates, investors must reallocate their risk. And the pent up demand for new, higher-yielding Treasuries could power prices higher while pushing yields down faster than Yellen can raise them. This is called an "unintended consequence." Each time Yellen moves yields a tad higher, massive demand will cause those new Treasuries to be devoured by mutual funds, institutions, insurance companies, banks and pension plans, that must then de-risk their portfolios. The inordinate selling volume from junk bonds and risky high-dividend issues may cause prices to implode. As these issues begin to collapse, and with the S&P 500 trading at 21 times earnings, some believe it would be reasonable for the Index to trade in line with its average long-term P/E of 16. If the S&P 500 falls 27 percent (from 21 to 16), it could be emotionally and financially bloody. And it makes me wonder what thousands of FED employees do each day. I doubt Yellen will raise rates anytime soon.

--------

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

©Copyright 2016 Creators.com

Published: Tue, Feb 09, 2016