Category: Economic Insight

Economic Insight

Rate Expectations

Interest rates around the world are at historic lows. They can only go in one direction from here, right? And aren’t rising interest rates bad for bond investors? The truth might surprise you.

Central banks in developed economies have injected extraordinary stimulus into the system since the recession arising from the global financial crisis five years ago.

The stimulus has come from these steep reductions in official interest rates and from more unconventional measures aimed at holding down long-term interest rates.

In 2013, markets became unsettled when the US Federal Reserve signaled it was contemplating a timetable for reducing its stimulus—the so-called “taper.” The central bank later changed its mind, and markets cheered the news.

In the meantime, many investors are asking what will happen to their portfolios when central banks do decide to start restoring rates to more normal levels.

The market values of bonds rise or fall depending on investors’ views about the outlook for inflation and interest rates, their perceptions about the creditworthiness of individual issuers, and their general appetite for risk.

The yield on a bond is the inverse of its price. So if the price falls, it means investors are demanding an additional return, or yield, on that bond to compensate for the risk of holding it to maturity. This sensitivity to interest rate change is called term risk.

So if interest rates can only go up from current levels, why hold bonds? There are a few points to make in response.

First, it is very hard to forecast interest rates with any consistency. Standard & Poor’s regular scorecard shows most traditional forecast-based managers fail to outpace bond benchmarks over periods of five years or more.1

Second, there is nothing to say that rates will return to normal very quickly. In the case of Japan, benchmark lending rates have been at or close to zero for the best part of 15 years. We have already seen many large bond fund managers make badly timed calls on when the cycle will turn.

Third, bonds perform differently from stocks. So regardless of what is happening with the rate cycle, there is a diversification benefit in holding bonds in your portfolio. Diversification is a way of managing risk and helping to target a smoother ride.

Fourth, if you look at history, there is no guarantee in any case that longer-term bonds will underperform shorter-term bonds when interest rates are rising.

We carried out a case study of four periods of rising rates from the past 30 years. To meet the test, the rate increases had to be spread out over 12 months or more and cumulative increase had to be at least 1.5 percentage points.

The four periods were December 1976–March 1980 (when rates skyrocketed by 15.25 percentage points), September 1992–June 1995 (3 points), November 1998–December 2000 (1.75 points) and June 2003–August 2007 (4.25 points).

The chart below looks at the performance of US government bonds during those four periods. We use standard indices: the Barclays Intermediate (1–10-year maturity, in blue) and the Barclays Long (10–30-year maturity, in green).

What’s notable in the chart is that in two of these four periods of rising interest rates long-term bonds did better than shorter-to-intermediate-term bonds. In the other two periods (1998–2000 and 1976–1980), longer-term bonds underperformed.

This may seem counterintuitive, but it can be explained by the fact that long-term bond holders, whose biggest concern is inflation, can be comforted by a central bank moving aggressively and pre-emptively against this threat by raising official rates.

Also note that seven of these eight bars show positive returns, which contradicts the view that bonds always deliver negative returns in periods of rising interest rates. The exception in this study is the late 1970s, when the longest-term bonds (10–30 years) suffered during a period of very sharp increases in rates.

So, the first lesson is that an increase in official lending rates set by central banks is not always replicated across bonds of all maturities. Indeed, in some cases, as we have seen, longer-term bonds have outperformed in rising rate environments.

The second lesson is that bonds can play an important role in your portfolio whatever the stage of the interest rate cycle. How much term (or credit) risk you take with bonds will depend on your own risk appetite and investment goals.

Trying to forecast interest rates is not a sustainable way of investing in bonds. But there is plenty of information in today’s prices on which to base a strategy. In the meantime, you can help temper risk by diversifying across different types of bonds, different maturities, and different countries.

Ultimately, the reasons for investing in bonds should be driven by your own needs, not by everybody else’s expectations.

By Jim Parker, Vice President, Dimensional Fund Advisors.  December 5, 2013

Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Performance data shown represents past performance and is no guarantee of future results. Performance for periods greater than one year is annualized. For illustrative purposes only.
Source: Barclays Capital data provided by Barclays Bank PLC.

Financial News for the Week Ending November 2nd

All the news you need to stay informed about what’s currently driving the market – courtesy of Raffa Wealth Management, LLC.

After hitting record highs during the week markets settled slightly higher on positive economic news.  The S&P 500 gained 0.1% and the Dow was up 0.3%.  Internationally, Japan rose 0.8% and Europe was up 0.4%.  The yield on the 10 year Treasury rose to 2.61%.  Article

Pending home sales fell 5.6% in September from August from a combination of higher mortgage rates and higher prices.  They are at their lowest level since December 2012.  Article

Retail sales rose 0.4% in September.

Concerns are rising that Europe’s inflation rate might be rising too slowly.  The rate fell to 0.7% in October from 1.1% in September to its slowest pace since the financial crisis.  Europe wants to avoid the fate of Japan which struggled with low inflation for two decades. 

US manufacturing rose to its highest level since 2011 in October despite the government shutdown for a portion of the month. 

China’s manufacturing index reached an 18 month high and new home prices rose. 

With half of the companies in the S&P 500 reporting, 75% have beaten profit estimates, while 52% have beaten revenue estimates.  Earnings are up 2.3% over last year. 

Apple had its third straight quarter of falling earnings, however there are signs that profit margins and prices are stabilizing. The firm sold 26% more iPhones this year than last year.  Article

Berkshire Hathaway’s earnings rose 29% in the third quarter driven by housing railroad and consumer sectors. 


Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at

Bonds are still a “Safe” Investment

Recently financial commentators have described bonds as not a “safe” investment.  However, it’s all relative.  If they mean that it’s not safe from losses, then sure it’s not a safe investment.  Almost any investment that has expectations for a positive return has the potential for loss.  More often than not though bonds have been compared to stocks, and bonds as a whole are certainly safer than stocks. 

The reason that bonds are no longer considered “safe,” they argue, is that the 30 year bull market for bonds is over and as interest rates rise, bonds lose money.  While it is true that rising interest rates are bad for bond appreciation, the losses are only temporary.  As bonds mature new bonds can be purchased at the prevailing higher interest rates.  Thus, any losses from falling bond prices are eventually replaced by gains from higher yielding bonds.

The primary purpose of maintaining an allocation to bonds is capital preservation as a balance against equities which are more volatile.  If an investor looks to move away from their target portfolio allocation, moving a higher percentage to stocks or cash than bonds simply because bonds look like they could lose more in the short term, than the investor is just engaging in market timing. 

A move to stocks (even those perceived to be undervalued) can then have significant negative consequences.  Since 1926 the worst 1 year period for a 5 year Treasury bond (a proxy for a high quality and short to intermediate term bond portfolio) has been a -5.55% return.  However, for US stocks the worst 1 year performance has been -67.57%.  Over a 3 year time frame, since 1926, the worst performance a 5 year Treasury bond has seen is a mere -0.41% annualized, whereas the US stock market has plummeted 42.35% a year over its worst three years.

A move to cash could be costly as well.  While safer, a move from bonds to cash assumes an investor would know precisely when to sell their bonds and precisely when to buy them back.  Such efforts to time the markets consistently cost investors – both in terms of unnecessary transaction costs and lower yields.

We recognize that there certainly is potential for rising interest rates.  In last month’s blog post we referenced what actions we take with clients’ bond portfolios in order to limit the effects of a rising rate environment.

Clearly, bonds can and have lost value.  Over the past thirty years bonds have experienced appreciation that is unlikely to be seen over the next 30 years.  However, they still serve a valuable function in an investment portfolio; providing stability.  Equity can experience wild swings in value which makes a 3-6% loss in a market weight bond portfolio seem minuscule.  One needs to look no further than recent examples like in 2008-2009 when global stocks lost 48.16%, or more recently the month of August in 2011 when global stocks fell 16.30%. 

If you see financial pundits saying how bonds are not a “safe” investment and that you should direct your investments to safer stock positions or cash, it would be better to just change the channel and not your investment portfolio.

Index Performance                                   June       2Q         YTD      Trl 1      

US Stock (Russell 3000)                               -1.30%    2.69%    14.06%  21.46%       
Foreign Stock (FTSE AW ex US)                 -4.27%   -2.79%     0.20%   14.43%       
Total US Bond Mkt. (BarCap Aggregate)    -1.55%    -2.32%   -2.44%  -0.69%        
Short US Gov. Bonds (BarCap Gov 1-5 Yr) -0.38%   -0.65%    -0.49%  -0.02%
Municipal Bonds (BarCap 1-10yr Muni)      -1.61%     -1.83%     -1.34%   0.34%
Cash (ML 3Month T-Bill)                              0.01%      0.02%     0.04%    0.11%      


Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at

Combating Rising Interest Rates

Interest rates in the US rose over the month on fears that the Fed would end its bond purchase program earlier than anticipated.  The 10 year Treasury yield rose from 1.70% to 2.16% and the broad bond market fell 1.78%.  As interest rates rise bond prices fall and thus large increases in interest rates can have a negative effect to a bond portfolio.  As a result of potential rising interest rates, how is RWM positioning your portfolio to reduce interest rate risk?

RWM is taking several steps to combat the potential harmful effects of rising rates.  First, we tilt the fixed income side of the portfolio from a market neutral allocation, which has an average maturity of approximately 7.3 years, to a shorter term position.  Short Term bonds are not as negatively affected by rising rates and thus, all else equal, short term bonds will see smaller losses than longer term bonds. 

Secondly, we diversify the portfolio broadly across bond sectors including corporate and government bonds.  Different types of bonds react differently to rising rates depending on the market cycle.  By diversifying the bond portfolio across many types of bonds it enables the portfolio to invest in bonds that are less sensitive to interest rate movements.

Finally, we diversify the portfolio internationally.  While rates may rise in the US, interest rates can be moving in different directions globally.  By exposing the portfolio to different yield curves it provides the potential to be invested in markets were rates are flat or falling.  The diversification potential is shown by the performance of international bonds when interest rates in the US are rising.  Since 1985, when viewing one year periods where rates have risen in the US, the index of short term international bonds has returned 4.8% compared to gains of only 2.3% for five year US government bonds and a loss of 0.3% for ten year government bonds.

The concern of interest rates rising is also a relatively short term issue.  As rates are rising the bond funds held in the portfolio are continually reinvesting maturing bonds in new bonds at the prevailing higher interest rates.  As a result the bond funds are buying bonds with higher yields and moving out of older lower yielding bonds, which help investors.  Thus, price declines are temporary losses until bond funds move into holding a portfolio of bonds issued at the higher existing rates.

While US interest rates rose in May and are likely to rise more in the future, by having a shorter term portfolio that is broadly and internationally diversified an investor can help mitigate the short term effect rising rates have on a bond portfolio.

Index Performance                                    May        YTD     Trl 1 yr.

US Stock (Russell 3000)                                 2.36%     15.55%    27.88%
Foreign Stock (FTSE AW ex US)                  -2.22%      4.67%     26.52%
Total US Bond Mkt. (BarCap Aggregate)     -1.78%     -0.91%       0.91%
Short US Gov. Bonds (BarCap Gov 1-5 Yr) -0.49%     -0.11%       0.35%    
Municipal Bonds (BarCap 1-10yr Muni)       -0.91%      0.27%       1.90%       
Cash (ML 3Month T-Bill)                                0.01%      0.03%       0.12%

Financial News 9/16/12 – 9/22/12


-The average price of gas is up to $3.85 almost 50 cents higher than it was in early July.  9/17

-Japan’s central bank announced moves to ease monetary policy following similar moves from other central banks.  The Bank of Japan increased its asset purchase program to $1.01 trillion and extended it 6 months.  9/19

-A survey of homebuilders’ confidence rose to the highest level in over 6 years.  9/19

-A preliminary September Chinese manufacturing survey indicated the 11th straight month of contraction in the country.  9/20

-The U.S. housing industry continues to rebound.  Housing starts increased by 5.5% in August, the highest gain in 28 months and sales of previously owned homes jumped 7.8% in August for their highest level in 27 months.  9/20

-Business activity in the Euro-zone sank at its fastest pace in over 3 years despite improvements from Germany.  9/21


-The NHL locked out its players as an agreement between the league and the players on a new collective bargaining agreement could not be reached before the deadline.  9/17

-Consumers are hot for Apple’s latest iPhone as Apple announced that there were more than 2 million preorders on the first day the iPhone 5 was available.  9/18

-Microsoft increased its dividend by 15% as it unloads some of its large cash stockpile.  9/19

-FedEx lowered its earnings expectations for its fiscal year yet again saying slowing global growth is hurting demand for shipping and will be weaker in 2012 and 2013 than previously estimated.  9/19

-Bank of America announced it will be cutting 16,000 jobs by year end in companywide cost cutting measures.  As a result the bank will no longer be the largest US bank by employees.  9/20

-Oracle’s fiscal 1st quarter earnings rose 11% but its revenues dipped 2% raising investors concerns.  9/21


-The price of oil sank $2.38 a barrel for the day and sank more than $3 in a minute confusing traders and drawing concern from regulators.  9/18

-Oil continued its fall dropping 3.5% on high inventories and weakening demand to end at $91.28 a barrel.  9/20

-U.S. Stock had their first down week of the month with the Dow falling 0.1% and the S&P 500 dropping 0.4%.  International stocks fell as well with Japan down 0.5% and Europe off 0.1% for the week.  9/22