Higher rates and debt-ridden companies

The interest rate spike slows money flow and make it more expensive for both businesses and consumers to borrow.

By Stock Traders Daily Aug 5, 2013 4:53PM

Image: $100 dollar bills © Image Source, age fotostockBy Neal Rau Stock Traders Daily

 

A recent spike in interest rates has helped ETF's like ProShares UltraShort 20+ Year Treasury (TBT) trade much higher; in fact TBT is up over 30% in the last three months alone. May was the worst month for U.S. Treasuries in two years, as stronger than expected data fueled worries the Fed might slow its bond purchases later in the year.

 

The obvious concern is higher interest rates slow money flow and make it more expensive for consumers and businesses to borrow. This slowing effect reduces the chance of inflation, but it is also a drain on corporate profits, which is bad for stocks.


Since the recovery began in 2009, both stocks and bonds have performed very well for investors despite weak economic growth, which is unusual. You do not have to be an economist to figure out that Fed policy is responsible. It is easy to understand why the market is so hypersensitive to the Fed’s every move. The Dow Jones pulled back almost 5% in June when Wall Street deciphered the Fed’s words as tapering was coming sooner rather than later. 


According to Bernanke, tapering of QE is dependent on economic conditions --  and if the economy slowed because of tapering, there could be an increase in the program again. Nevertheless, Bernanke has indicated that it may begin to pull back on its stimulus policy as early as the end of 2013.

 

Some sectors like regional banks could benefit, because of higher long-term rates that might improve lending margins. On the other hand, companies with high debt who depend on borrowing might see their stocks suffer in a rate rising environment. The S&P 500 has about two dozen companies (not including utilities and financials) with debt levels that exceed 65% of their market value. Obviously, these companies would see their borrowing costs rise if they need to roll over debt.  Stock Traders Daily has identified some of these higher debt companies like Micron Technology (MU) and First Solar (FSLR), who are also among the biggest winners in the S&P 500.

 

Cash-rich technology stocks may hold up better in a rising interest rate environment, but with the Nasdaq at 13-year highs many stocks are trading near all-time highs. This might be a good time to start hedging against a potential rise in rates.  Stock Traders Daily provides real time trading reports  for TBT, ProShares UltraShort 7-10 Year Treasury (PST) and iShares Barclays 20+ Yr Treasury Bond (TLT). 

 

As investors keep a close eye on the Fed and the gradual unwinding of QE, they are going to have to get used to the idea that rates will go up. 


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