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Rising Interest Rates

Rising Interest Rates

How might they affect investments, housing & retirees?

 

Provided by MidAmerica Financial Resources

    

How will Wall Street fare if interest rates climb back to historic norms? Rising interest rates could certainly impact investments, the real estate market and the overall economy – but their influence might not be as negative as some perceive.  

 

Why are rates rising? You can cite three factors. The Federal Reserve is gradually reducing its monthly asset purchases. As that has happened, inflation expectations have grown, and perception can often become reality on Main Street and Wall Street. In addition, the economy has gained momentum, and interest rates tend to rise in better times.

 

The federal funds rate has been in the 0.0%-0.25% range since December 2008. Historically, it has averaged about 4%. It was at 4.25% when the recession hit in late 2007. Short-term fluctuations have also been the norm for the key interest rate. It was at 1.00% in June 2003 compared to 6.5% in May 2000. In December 1991, it was at 4.00% – but just 17 months earlier, it had been at 8.00%. Rates will rise, fall and rise again; what may happen as they rise?1,2

 

The effect on investments. Last September, an investment strategist named Rob Brown wrote an article for Financial Advisor Magazine noting how well stocks have performed as rates rise. Brown studied the 30 economic expansions that have occurred in the United States since 1865 (excepting our current one). He pinpointed a 10-month window within each expansion that saw the greatest gains in interest rates (referencing then-current yields on the 10-year Treasury). The median return on the S&P 500 for all of these 10-month windows was 7.93% and the index returned positive in 80% of these 10-month periods. Looking at such 10-month windows since 1919, the S&P’s median return was even better at 11.50% – and the index gained in 81% of said intervals.3

 

Lastly, Brown looked at the S&P 500’s return in the 12-month periods ending on October 31, 1994 and May 31, 2004. In the first 12-month stretch, the interest rate on the 10-year note rose 2.38% to 7.81% while the S&P gained only 3.87%. Across the 12 months ending on May 31, 2004, however, the index rose 18.33% even as the 10-year Treasury yield rose 1.29% to 4.66%.3   

 

The effect on the housing market. Do costlier mortgages discourage home sales? Recent data backs up that presumption. Existing home sales were up 1.3% for April, but that was the first monthly gain recorded by the National Association of Realtors for 2014. Year-over-year, the decline was 6.8%. On the other hand, when the economy improves the labor market typically improves as well, and more hiring means less unemployment. Unemployment is an impediment to home sales; lessen it, and more homes might move even as mortgages grow more expensive.4

 

When the economy is well, home prices have every reason to appreciate even if interest rates go up. NAR says the median sale price of an existing home rose 5.2% in the past year – not the double-digit appreciation seen in 2013, but not bad. Cash buyers don’t care about interest rates, and according to RealtyTrac, 43% of buyers in Q1 bought without mortgages.4,5

 

Rates might not climb as fast as some think. Federal Reserve Bank of New York President William Dudley – whose voting in Fed policy meetings tends to correspond with that of Janet Yellen – thinks that the federal funds rate will stay below its historic average for some time. Why? In a May 20 speech, he noted three reasons. One, baby boomers are retiring, which implies less potential for economic growth across the next decade. Two, banks are asked to keep higher capital ratios these days, and that implies lower bank profits and less lending as more money is being held in reserves. Three, he believes households and businesses are still traumatized by the memory of the Great Recession. Many are reluctant to invest and spend, especially with college loan debt so endemic and the housing sector possibly cooling off.6

    

Emerging markets in particular may have been soothed by recent comments from Dudley and other Fed officials. They have seen less volatility this spring than in previous months, and the MSCI Emerging Markets index has outperformed the S&P 500 so far this year.2

   

MidAmerica Financial Resources may be reached at 618.548.4777 or greg.malan@natplan.com.

www.mid-america.us

    

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

    

Citations.

1 - newyorkfed.org/markets/statistics/dlyrates/fedrate.html [5/22/14]

2 - reuters.com/article/2014/05/21/saft-on-wealth-idUSL1N0NZ1GM20140521 [5/21/14]

3 - fa-mag.com/news/what-happens-to-stocks-when-interest-rates-rise-15468.html [9/17/13]

4 - marketwatch.com/story/existing-home-sales-fastest-in-four-months-2014-05-22 [5/22/14]

5 - marketwatch.com/story/43-of-2014-home-buyers-paid-all-cash-2014-05-08 [5/8/14]  

6 - money.cnn.com/2014/05/20/investing/fed-low-interest-rates-dudley/index.html [5/20/14]


The Question Marks Surrounding Wall Street Trading

What don’t we know about the way the markets work?

 

Provided by MidAmerica Financial Resources

    

In a perfect world, the financial markets would be entirely transparent and without mysteries. In this imperfect one, we have financial markets reliant on high-speed trading and dark pools, both of which are imperfectly understood. Thanks to the bestselling Flash Boys: A Wall Street Revolt and other journalistic efforts, the public is more aware of them.

  

While alternative trading platforms such as IEX (founded by Brad Katsuyama, the central figure of Flash Boys) have emerged, the anxieties remain. Reforms to U.S. market structure take time – often, too much time. At present, as Flash Boys notes, major U.S. exchanges such as the NYSE and NASDAQ have sold prime access to their premises to high-frequency trading networks, giving that software a clear competitive advantage over fund managers and individual investors.1

       

Q: Does high-speed trading hurt individual investors? Lewis (who used to work on Wall Street before becoming a journalist) contends that the machinations of high-frequency trading amount to “computerized scalping” with the small investor paying a “tax” of half a percent (or less) per trade. Some economists and consumer advocates have argued for a “Robin Hood” tax in response – a surcharge of 3 basis points on financial transactions, with revenue generated going to the Treasury and helping to whittle down the federal budget deficit. Other economists call that a lousy idea, saying that taxing trading would only amount to a tax on savings – any such levy would ding the small investor even more, they argue, and Wall Street firms would just hunt for ways to avoid the tax.2

     

Other stock market analysts feel high-speed trading helps investors more than it hurts them , citing what they see as improved market liquidity and referring to the reduction in bid-ask spreads (the differential between what buyers want to pay for a stock versus what sellers believe it is worth). Since the mid-1990s, bid-ask spreads have narrowed from the vicinity of 90 basis points to about 3 basis points as an effect of such trading networks.3

 

Q: How long will high-speed trading rule the markets? It doesn’t really “rule” them at the moment, but it does account for about half of all U.S. market volume right now. If it is any comfort, the percentage of market activity conducted via algorithmic trading platforms declined by 10% in the current bull market (according to The Atlantic, it went from 61% in 2009 to 51% in 2012).3

   

Q: What really goes on in dark pools? For the uninitiated, dark pools are the private trading platforms maintained by banks. We can’t see what goes on inside these private trading venues, as they aren’t public exchanges like the NYSE or NASDAQ. The SEC is finally investigating them – its current chair, Mary Jo White, thinks they “risk seriously undermining” the credibility and validity of stock prices.4

 

Dark pools account for about 40% of equities trading in America, and they aren’t policed nearly as much as the public exchanges. As there are 11 public stock exchanges in this country compared to 40+ dark pools, there seems to be a sizable amount of trading going on behind closed doors.4

 

Brad Katsuyama, the former Royal Bank of Canada trader who spearheaded the reform movement chronicled in Flash Boys, plans to introduce a pricing system that will let most banks and brokerages trade on the IEX platform for free – a move that might encourage them to get out of the dark pools (where they face no fees that they would ordinarily incur for trading on the public exchanges) and bring more of their trading into the light. But even IEX currently operates as a dark pool – though it plans to register with the Securities and Exchange Commission soon and become a full-fledged exchange – and its proposed pricing system would explicitly favor brokerages over individual investors.4

   

Will trading ever truly be transparent? It would be naïve to think so, but there is room for improvement. When even key players on Wall Street admit that they have been in the dark about trading mechanics (as Michael Lewis discovered in researching Flash Boys), something has to change and change soon. 1

   

MidAmerica Financial Resources may be reached at 618.548.4777 or greg.malan@natplan.com.

www.mid-america.us

     

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

    

Citations.

1 - tinyurl.com/kuah7pf [4/1/14]

2 - nytimes.com/2014/04/08/business/argument-for-financial-transaction-tax-regains-footing.html [4/8/14]

3 - theatlantic.com/business/archive/2014/04/everything-you-need-to-know-about-high-frequency-trading/360411/ [4/11/14]

4 - tinyurl.com/lac32yy [7/7/14]





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