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Rising interest rates make it unattractive to hold long-term bonds. For example, when interest rates jump from 3% to 4%, the net present value of 10-year bond d

by Hermel 11y ago

Rising interest rates make it unattractive to hold long-term bonds. For example, when interest rates jump from 3% to 4%, the net present value of 10-year bond drops by 10%. So as soon as investors believe that the turning point has come, the rational reaction is to sell bonds, amplifying the raise in interest rates even more. But where will they put that money instead? Letting it sit around in cash is not a wise idea because oftentimes, rising interest rates come hand in hand with inflation. Your best bet is to buy something of "real" value, be it gold, real estate, or stocks. In my opinion, this could explain the growing divergence between stocks and bonds. At least for a while, I would expect this to continue and stocks to go up with bonds falling, or at least stocks not fall as much as bonds. Then again, it is very hard to predict such things.

mrfusion 11y ago
But according to the fed model [1] stock prices decline when interest rates rise. How do you account for that? [1] http://en.wikipedia.org/wiki/Fed_model http://en.wikipedia.org/wiki/Fed_model
- typedweb 11y ago
  People are less willing to borrow money to buy stocks at higher interest rates.
- blahblah3 11y ago
  It depends on the real interest rate. Suppose you buy a long term bond yielding 5%, inflation was 2%. Now rates of bonds w/ comparable maturity and credit go up to 7% and inflation goes up to 4%. Your bond is going to be worth a lot less now, but stocks could be (in reality not necessarily...) more robust to this change.
zhte415 11y ago
> Rising interest rates make it unattractive to hold long-term bonds. For example, when interest rates jump from 3% to 4%, the net present value of 10-year bond drops by 10%. So as soon as investors believe that the turning point has come, the rational reaction is to sell bonds, amplifying the raise in interest rates even more. The rational reaction for a trader that believes they know more than the market and are looking to realize gain today. On the other hand, if an investor knows they have liabilities that match what a long term bond offers and are fully funded, and they don't care for second-guessing every other day, they're likely to not move out, or to move out a bit only. > Then again, it is very hard to predict such things. Indeed. Though as / when / if interest rates rise, how they do so at different points on the yield curve can suggest interesting things. Just as long term bonds are at unnaturally high prices, I postulate that stocks are too, based on PEs over the past 10 decades or so (very Shiller). Might be worth looking elsewhere. Inexpensive (not cheap) real estate makes a huge amount of sense, especially in developed countries where a huge inflow of capital is flowing, and with easy visa deals, will continue to.

by Hermel 11y ago

mrfusion 11y ago

But according to the fed model [1] stock prices decline when interest rates rise. How do you account for that? [1] http://en.wikipedia.org/wiki/Fed_model http://en.wikipedia.org/wiki/Fed_model

typedweb 11y ago
People are less willing to borrow money to buy stocks at higher interest rates.
blahblah3 11y ago
It depends on the real interest rate. Suppose you buy a long term bond yielding 5%, inflation was 2%. Now rates of bonds w/ comparable maturity and credit go up to 7% and inflation goes up to 4%. Your bond is going to be worth a lot less now, but stocks could be (in reality not necessarily...) more robust to this change.

zhte415 11y ago

> Rising interest rates make it unattractive to hold long-term bonds. For example, when interest rates jump from 3% to 4%, the net present value of 10-year bond drops by 10%. So as soon as investors believe that the turning point has come, the rational reaction is to sell bonds, amplifying the raise in interest rates even more. The rational reaction for a trader that believes they know more than the market and are looking to realize gain today. On the other hand, if an investor knows they have liabilities that match what a long term bond offers and are fully funded, and they don't care for second-guessing every other day, they're likely to not move out, or to move out a bit only. > Then again, it is very hard to predict such things. Indeed. Though as / when / if interest rates rise, how they do so at different points on the yield curve can suggest interesting things. Just as long term bonds are at unnaturally high prices, I postulate that stocks are too, based on PEs over the past 10 decades or so (very Shiller). Might be worth looking elsewhere. Inexpensive (not cheap) real estate makes a huge amount of sense, especially in developed countries where a huge inflow of capital is flowing, and with easy visa deals, will continue to.