Time to sell stocks and move to fixed income

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Interest rate hikes change the picture
Don & Jon Vialoux
Technical Analiysis


U.S. TREASURIES SET FOR SUMMER RALLY

Okay everyone...listen up...we're calling it: we've hit the bottom in interest rates administered by the Federal Reserve and Bank of Canada. Rates have held at significantly low levels for months now and investors are anxiously anticipating the "hike" to surely come.

The Bank of Canada already is hinting about rate hikes as early as June. The Fed is hinting about a Fed Fund rate hike in the second half of 2010. Should you stay in stocks or move to fixed-income products?

Anticipation of a pending increase already has already sent bond yields and bank lending rates higher. The higher cost to borrow for investment purposes is already eating away at your portfolio. T-bill yields have begun to rebound from lows not witnessed since the 1950s. Yields on 10-year U.S. treasuries recently pushed through 4% and expectations are they will remain between 4% and 4.75% for an extended period.

Successful equity investors, who entered equity markets a year ago, are concerned a U.S. rate increase will dampen economic recovery and trigger a stock market retreat. These investors have had gains of over 100% since the market bottom a year ago. They have become known on Bay Street and Wall Street as "the Bubble Boys."

Let's examine the impact on U.S. equity markets before and after Fed Fund rate increases during the past 55 years. The Dow Jones Industrial Average averaged gains of 0.41%, 0.99% and 1.94% over 30, 60 and 90 day periods, respectively, before the rate hikes. Investors juiced what they could from lenders to put money to work at relatively low rates.

After a Fed Fund rate increase, the Dow Jones Industrial Average recorded an average decline of 0.8% over the next 30 days followed by declines during the next 60 and 90 days surpassing 1.25%. Out of the 70 periods after a Fed Fund rate increase, only 25 recorded positive equity market returns after 30 days.

History provides the proof: Rate hikes end stock market rallies. Quick gains from a recovery in deflated equity values are no longer are available. Equity markets are entering a period of stock picking. We hope you've remembered your investment advisor's telephone number after throwing it out the window after the crash of 2008.

Negative tendencies after rate hikes hurt commodity prices as well. Gold and oil recorded losses of 4.38% and 1.49%, respectively, in the 30 days after the move.

Coincidentally, the period of seasonal strength for fixed income products is approaching. Seasonal studies show that yields on long-term U.S. treasuries peak and treasury prices bottom at the beginning of May. The seasonal trade for long term U.S. bonds is lining up nicely this year. Yields on long-term treasuries have trended upwards during the past month and a half. Treasury prices are set for their traditional annual low period followed by seasonal strength from May to December. As investors take notice, they will begin to shift from equity investments into fixed income investments.

Equities have reached highs not seen since before the recession. A central bank administered interest rate increase may be the catalyst that brings to an end the period of dramatic short-term gains in equity markets. T-bills and bonds will become the investment vehicle of choice as the second half of 2010 approaches.


Read more: http://www.financialpost.com/tod ... 18024#ixzz0lPGRPoHA

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