Securities That May Survive Upcoming Interest Rate Jolts

Posted on July 25, 2013 by

6



We saw in May and June 2013 that a hint of change in monetary policy can lead to a simultaneous drop in stocks and bonds. What could we add to a portfolio to protect against that risk?

keywords: asset allocation, risk parity, diversified portfolio

Until the Fed makes a concrete change in policy, we’re under the gun

As I wrote in a recent blog:

The end of QE3 is concretely on the horizon. It seems that news (or even rumor) of Fed policy change will drive stock and bond prices more significantly than any other factor. Actual changes in policy are certainly ahead so we will see more market responses like the May/June dip in the future as they take effect.

After that post, a few people asked me: How can we protect ourselves against jolts like this in the future?

We want securities that are solid and that also performed well in May and June

Because the May/June slip was due to interest rate risk, perhaps we can infer that stocks that did well then have some immunity.  So lets look back to the recent May/June drop and see if we can find stocks and ETFs that weathered that storm well.

Also keep in mind that a key reason for the recent drop was that the Fed was considering to tighten monetary policy because the economy is improving. Indicators of this improvement include more new home starts, improved consumer sentiment, and more people going back to work. So I’m going to bias my search a bit in favor of those factors.

How I found these symbols:

I used Lucena’s QuantDesk software in the following ways: First I used QuantDesk’s Event Analyzer to find stocks and ETFs with the highest 60 day Sharpe Ratio as of the end of June. Translation: These securities had strong return and low volatility during May and June. Second, I used QuantDesk’s Hedge Finder to discover additional securities that balance the StumpGrinder portfolio.

I’m going to overhaul StumpGrinder’s holdings based on these findings.

Securities that survived the May/June interest rate risk scare

  • VYM  Vanguard High Dividend Yield (ETF):  Of the existing StumpGrinder holdings, this one performed best.
  • HD Home Depot, and LOW Lowes: These stocks enable us to capture returns from the improving housing market as well as consumer confidence. Also, they are less susceptible to interest rate risk than homebuilder ETFs, which dropped in May/June (and today!) because of their exposure to mortgage rate issues.
  • F Ford, GM General Motors: These US car makers have been doing great, they blasted through May and June. Consumers love cars. Their Japanese counterparts Toyota and Honda did not perform as well.
  • ADP Automatic Data Processing Corp, PAYX Paychex: These two companies process payroll for thousands (millions?) of companies. If people are going back to work, they need payroll. These two were up in May and down slightly in June, so this is a play more about the improving economy and lower unemployment than strong May/June performance.
  • IJT iShares S&P SmallCap 600 Growth (ETF): Apparently small cap companies are not exposed to interest rate risk in the same way as other parts of the market.
  • KRE SPDR KBW Regional Banking (ETF): I don’t yet have a solid theory on why this sector did well, but they powered through May and June.
  • BRK.B Berkshire Hathaway: Everybody needs insurance.
  • NOC Northrop Grumman, RTN Ratheon: Two top defense contractors that have performed well YTD and also through May/June.
  • PJP PowerShares Dynamic Pharmaceuticals(ETF), XPH SPDR S&P Pharmaceuticals (ETF), IYH iShares Dow Jones US Healthcare (ETF): Healthcare and drugs.

Disclosure:

Tucker Balch holds a long position in VYM, and expects to include some of the symbols above in his portfolio. Tucker Balch is not an investment advisor.

Advertisements