June 19 and 20 brought a sharp sell-off in bonds, which spread to the stock market. This was all caused by Fed Chair Ben Bernanke's press conference on Wednesday afternoon where he outlined his timeline to reduce the pace of bond purchases and eventually end the accumulation by the middle of 2015. This spooked the markets and caused bond yields to rise; hurting almost everyone's portfolio.
How do you position yourself for rising interest rates?
Aside from the obvious call to sell long-term bonds, there are certain stocks that are likely to benefit from rising rates. Some of these picks are obvious, such as large banks that will benefit from being able to charge higher interest on loans. Others picks are less obvious. We suggest considering stocks that have large amounts of net cash and/or short-term investments on the balance sheet. The reasoning being that as rates rise, the gains from interest on this cash and cash equivalents will increase as well. Commercial paper, where much of this cash is parked, is short maturity, and can be easily rolled over into higher-yielding issues as current holdings mature.
Our top pick
Apple (AAPL) is sitting on the biggest cash hoard of any public company. It is positioned well for rising rates because it doesn't need to raise any debt and has mountains of cash. As of the quarter ending March 29, it had cash and cash equivalents of $12.05 billion, short-term investments of $27.08 billion and long-term investments of 105.55 billion. The grand total is $144.68 billion, which is roughly 30% of the company's total market capitalization. How much could rising rates help Apple? It would provide a windfall measured in the billions for annual profits. Let's suppose rates rise by 1.00%. $144.68 billion times 1.00% is $1.45 billion, per year in additional profit. If rates rise by 2.00%, profits would increase by $2.89 billion. I think you get the idea. What's more compelling is that the bonds it recently issued become less valuable as rates increase, allowing Apple to book an accounting profit on the reduction in the debt. It is essentially shorting its own long-term bonds, while at the same time investing in short-term securities. Traders who made money when long-term bonds lost value have done the same thing. They are buying cash like instruments and selling high-duration bonds. Apple seems to be behaving like a fixed income trader and appears to have been a pretty smart one at that considering the perfect timing of the bond offering.
Here are a few more stock ideas to position yourself for rising rates
Microsoft (MSFT) is our number two pick for stocks to own in a rising rate environment. Microsoft has $5.24 billion in cash and $69.24 billion in short term investments. All told the company is sitting on a coffer of $74.48 billion in interest-generating ability. Cisco (CSCO) is another interesting pick as it has $45 billion of cash ($9.00 per share) on the balance sheet. What's better, is that unlike Apple, virtually all of this $45 billion is in cash and cash equivalents. So this represents the most liquid and shortest maturity assets possible.