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Much has been made of the decline in interest rates since the start of 2014. Many investors expected interest rates would continue to rise as a result of the Fed's "taper" announcement in May of last year. The market action subsequent to the taper announcement certainly saw the yield on the 10-year Treasury rise, ultimately reaching over 3% at year-end 2013. So far in 2014, though, the yield on the 10-year Treasury has managed to decline to just under 2.5%.

From The Blog of HORAN Capital Advisors


In a recent report by S&P's Sam Stovall, he notes the higher-yielding (2.5%+ yield) sub industry groups delivered the worst performance following the Fed's taper comment. Additionally, for the past one year, the higher-yielding sub industry groups' performance has lagged the lower-yielding (less than 1.5% yield). Will this underperformance by the higher-yielders continue as a result of potentially higher interest rates for the balance of 2014?

From The Blog of HORAN Capital Advisors


A portion of S&P's conclusion centers around their belief interest rates will trend higher through the balance of this year and into 2015. Specifically, S&P notes,

In a possible preview of coming attractions, S&P Capital IQ thinks investors should proceed with caution, especially those who are starving for yield and seem to be on a constant quest for cash. Our advice is to regard last year's knee-jerk reaction to higher rates, as well as the restrained recovery, as a possible preview of coming attractions when rates move higher once again.
From April 30, 2013 through the end of the year, the yield on the 10-year Treasury note rose from 1.7% to slightly more than 3%. Now it has drifted back down to 2.5%, in what we believe is a counter-trend rally before moving higher once again as economic data confirm the improvement in U.S. GDP growth. Indeed, Standard & Poor's Economics, which operates independently of S&P Capital IQ, projects the 10-year yield to end 2014 around 3.1% and creep even higher by the end of 2015 to near 3.5%. In addition, even though history should be viewed as a guide and not gospel, the monthly difference between headline CPI and the yield on the 10-year note during the past 60 years implies a year-end 2014 level that approaches 4%.
Taken from an individual stock perspective, investors should consider returns during the past year, along with valuations, when making investment decisions. S&P 500 companies yielding 2.5% or more recorded an average total return of 11%, versus 19% for all companies in the "500," and 25% for those yielding 1.5% or lower. Even more telling, is that nearly one-quarter of all companies yielding 2.5% or more are still under water, having recorded a decline in price and dividend in the past year. This percentage of decliners is more than 10 percentage points higher than the average for those companies yielding less. And while valuations (P/E ratios based on forward-year EPS estimates) for the higher-yielding category is currently below the lowest yielding category, they trade at a 20% premium to the middle-yielding group and for the cap-weighted S&P 500 Index.

As a final comment on interest rates, many investors have been surprised by the rate decline that has occurred this year. It may seem unlikely that rates will continue their decline from these low levels; however, JPMorgan's net treasury survey shows investors are the most short treasuries since 2006. If investors need to cover their shorts as a result of a further decline in interest rates, the increased treasury demand will push treasury prices higher, i.e., yields decline. Certainly, a lot is going on in the bond market that is attempting to prove the consensus wrong.

From The Blog of HORAN Capital Advisors


Sources:

Source: High-Yield Stocks Underperform In Rising Interest Rate Environment