Over the past three decades, interest rates have steadily declined. Now that rates are finally rising, bond as well as equity investors should be wary of certain areas in the markets. Investors must be aware that rising interest-rate pain is not limited to long-term bonds. There are a number of sectors in your portfolio that can be negatively affected by rising interest rates.
Potential problem areas, along with why they have struggled lately include:
• Treasury Inflation-Protected Securities (TIPS) fell more than 7 percent. TIPS, like Treasuries with longer durations, suffered in a rising rate environment. In addition, tame inflation has further reduced demand for securities with built-in inflation protection.
• Emerging-market debt declined more than 9 percent. Emerging debt has been among the worst-performing bond assets as rates increased. Rising Treasury yields make riskier emerging-market bonds less attractive – the tighter yield spreads would no longer justify the added risk. Moreover, emerging-market local currencies have been depreciating against the U.S. dollar, which further dragged on bonds denominated in the currencies.
• Emerging-market stocks dropped more than 10 percent. Along with rising rates, emerging markets weakened on slowing growth in key markets, notably China and India, and the appreciating U.S. dollar.
• Utilities dipped more than 6 percent. Utilities typically suffer when bond yields rise as investors shift away from safe-haven, dividend stocks for better opportunities. Moreover, utilities have already experienced robust returns. In addition to so-so valuations, utilities are apt to remain rate-sensitive for the foreseeable future.
• Real estate investment trusts decreased more than 7 percent. REITs also suffer when bond yields rise. REITs rely on borrowing to run their business, so they are vulnerable to the level of interest rates. Additionally, REITs have been generating robust returns over the past five years and are beginning to look overvalued as yields diminished.