Watch Long Term Interest Rates
Research for Online Investors

by John Dalt

12/13/10

Interest rates are heading higher, and there doesn’t seem to be anything the Fed can do about it. I am always mindful of the old saying “You can’t fight city hall.” In the past, when the Fed announced quantitative easing, it was time to get out of the way. They have deeper pockets than I do.  But, the market may be signaling us to watch for a correction in equities.

Something funny has been happening since QE2 was considered in August and began in the fall, long term interest rates are moving higher! They should move lower, overnight rates are at 0.0% to 0.25% and the Fed is buying paper from 30 months to seven years maturity.

The price of the TLT moves higher as current interest rates decline, and lower as current interest rates increase.  Simply put, treasures that pay a fixed interest rate are worth more than their “face” value if current rates offered are less than the coupon rate of the bond.  The opposite is true, treasuries that pay a fixed interest rate are worth less than their “face” value if current rates offered are more than the coupon rate of the bond.

The chart below shows the TLT 20-year Treasury ETF.

TLT reflects this movement of the value of the ETF's bond portfolio as it relates to current rates.  This three-year chart lets us see the credit crisis in late 2008 and the resulting lower interest rates as the Treasury and Fed pumped money into Banks and the market.  After the low of 666 on the S&P 500 in March of 2009, interest rates rose as investors looked for a safe harbor.  This drove the TLT down to its low in June.

Then we see the original quantitative easing that ended last spring in March.  We remember what happened in April, the market fell back from its highs.  We continued bouncing lower in the stock market until July 1, when we seemed to catch our legs.

Since September the TLT has been moving lower, as long term interest rates worked higher (and TLT lost value). It is not a perfect predictor, but a fall of the TLT from $95.50 in Oct. 2008 to $85.00 at the end of March represented an 11% drop. The stock market fell two weeks later. TLT hit 109.34 on 8/25 and now is at 93.62, a 14.4% drop in value.

Here is the S&P 500 chart.  We can’t call them mirror charts, but…

Watch your trailing stops.  When interest rates rise, in spite of the Fed’s quantitative easing, we wonder if there is another shoe to drop.  Higher interest rates will eventually entice investors to move to the safety of fixed term investments, especially if the equities market experiences “turbulence.”

To the mailbag:
This covered call trading sounds interesting but I don't
have a warm fuzzy on how it works.- paid up subscriber R.V.

John’s reply:  We buy 100 shares of Ford (F) for $16.58  We sell 1 contract to sell 100 shares of F for $17.00 on the third Friday in Dec. for $60.00  If F is $17.00 or higher on said third Friday, the stock is "called away" and we receive $17.00 in our account.  If it closes less than $17.00 the option expires, and we sell a new call option for Jan or Feb delivery.  It is called a "covered call" because we own the underlying stock and can make delivery.  It would be a "naked call" if we did not own the stock.  I hope this helps you.  You should subscribe to our Buy, Sell, Hold service; it is safe in any market, and makes money.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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