Reader Q+A: Protection Against Rising Interest Rates

Reader Ken emailed the following question that has repeatedly come up from time to time:

I am wondering if you could foresee what the wisest investments should be for upcoming increasing in interest rates? It is obvious these low rates cannot go much lower or last much longer so there must be some place for the forward thinking investor to get a bargain.

While I agree with you that interest rates will have to rise at some point in the future, it is still an unknown as to what will trigger such a directional change. To my way of thinking, there could be two events:

1. Economic activity picks up on its own or with assistance from the Fed as QE-2 is being implemented. In its initial stages, QE-2 is designed to keep interest low to give a boost to the economy. I repeatedly have posted that I do not believe that this program will work, and it will likely end up failing and join the previous stimulus packages in a yet to be named graveyard.

If the economy makes no headway, and just muddles along (very likely in my view), that in theory should keep interest rates low for the foreseeable future.

However, there have been some rumblings that the good old U.S.A. may no longer be issuing debt that the rest of world considers worthy of being AAA rated. After all, we have indebted ourselves for generations to come.

Then we might potentially face this scenario:

2. The fact that the quality of our debt may no longer be considered AAA, yet we still have tremendous borrowing needs, means we may have to pay more via higher interest rates to continue our borrowing binge.

You think our debt is still AAA? Just on Wednesday, I posted that a Chinese rating agency reduced our credit rating to A+ from AA citing a “deteriorating intent and ability to repay debt obligations” in view of the Fed’s recent stimulus plan.

That to me that is the biggest threat to low interest rates! Due to our debt burden, our need to borrow will be ever-present, which means we may have to pay whatever the market is willing to offer. Let’s hope it does not turn out like Greece, Portugal, Spain, Ireland and/or others.

Given that, how can an investor prepare himself for the inevitable? Unfortunately, there is no clear cut answer, as we are on the back side of a busted real estate/credit bubble of epic proportions with no precedent. In other words, we are in unchartered territory.

You simply can’t anticipate not only which asset class may benefit, but you also do not know the time frame. And simply guessing is the worst you can do. Case in point is that some newsletter writers advised shorting bonds late last year anticipating higher interest rates. Well, rates plunged, and those following that advice had their heads handed to them on a silver platter.

A far better way is to follow trends in the market place. Take BND, the total bond market for example, which we have positions in. BND has come off its high but remains above its long term trend line, which means we are still in a period of low interest rates. Once the trend line is being broken to the downside, watch out; higher rates may be ahead.

To look at the big picture, make it a point to review the weekly StatSheet, especially the “ETF Master” section. It ranks all ETFs I monitor and, by looking at the %M/A column (% of a fund above or below its long term trend line), you can easily spot changes as one ETF moves below its respective trend line and another one moves above it.

To me, that is the best way I know of to determine when/if trend changes in the markets occur. If an asset class has been in negative territory and is moving above its trend line and becoming bullish, that should get your attention. If you combine these changes along with those occurring in the “Bear Market Funds section,” you will always know when momentum shifts and adjust your holdings accordingly.

I don’t have the crystal ball to guess when changes will occur, but using my free published StatSheet data will give you a heads up by keeping you informed of any important trend changes in the domestic and global market place.