With Interest Rates Rising, Consider These Low-Risk Stock Alternatives

With stock prices soaring and the 10 year Treasury yield now back above 3%, the question is, “Is it time to switch?”

If you have followed my advice to get out of the stock market–advice which was too early, but that I’m convinced is still valid for the long haul–then the first part of the question has already been answered. You are mostly in cash.

And by cash, we mean money in interest bearing insured bank accounts, or CDs, or US Treasury Bills.

But we should always shop for the best deal.

So today, I want to share with you some of these great risk-free alternatives to stocks.

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The Short Term Points to T-Bills as Our Best Low-Risk Alternative

First, let’s look at a couple of your shortest term options.

These would be Treasury bills or short term notes that you could purchase without fees direct from the US Treasury through their Treasury Direct website. There you can open an account similar to a bank CD account and manage your T-bill holdings via your web browser.

Through this account you can purchase not only short term T-bills, but also longer term notes and bonds. The only difference between notes and bonds is the term. Notes have a term of 10 years or less when issued. Bonds have a term of 11-30 years.  The Treasury offers a guided tour to introduce you to these accounts.

When interest rates are rising, like now, you’ll want to hold just short term paper. You can set it up to roll over your holdings as they mature or pay the cash back to your bank account.

But when rates start to plateau you may want to extend the term of your holdings by buying notes and bonds to lock in higher rates for the long term.

When there’s uncertainty about rates, you could do what bond pros call “laddering.” This is a strategy for that involves purchasing fixed income securities with different maturity dates, to capture solid interest income returns without needing to try to time the market.

But the question here is one of market timing. After a decade of paying virtually zero, investors can finally look forward to getting a return on their savings, with virtually no risk. And longer term yields are rising.

So should we extend duration now?

Let’s first look at what bond traders call the “short end of the curve.”

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This “Short End of the Curve” Provides Insight into the Ideal T-Bill Duration

Let’s consider 13 week Treasury bills and 2 year Treasury Notes. This will help us determine which one to buy.

Here’s a chart of the 13 week bill rate:


This chart is spectacular! It’s a dramatic picture of just how fast the money market is tightening as the Fed pulls money out of the system, while the US Treasury keeps needing more and more cash to pay its bills.

In just a year, the 3 month bills have soared from paying 1% to 2.17%, and there’s no end of that in sight.

Remember, the Federal budget deficit has ballooned because of the Trump tax cut and the subsequent Budget Busting Agreement (BBA) that has sent spending soaring. The Federal Government is burying the money market with massive amounts of new debt, month in and month out. And there’s no reason to believe that this will end any time soon. Likewise, massive deficit spending is likely to assure that economic data will remain positive for the foreseeable future. So there’s little likelihood that the Fed will back away from tightening.

Therefore, for now I believe the best thing to do is just keep buying 13 week bills and rolling them over until there are signs that the tightening is coming to an end. That would require what Janet Yellen referred to as a “material adverse event” and what I interpret as severe economic contraction or a massive stock market plunge.

A Glimpse at Long-Term Treasuries Shows Why to Avoid Them

So what about reaching for more yield by buying a 2 year Treasury note?

Let’s look at the 2 year note yield chart:


Amazingly, in the past year the 2 year note yield has soared from 1.3% to 2.81%. Again, there’s no end of that in sight as long as the economic data stays robust.

So should we opt to buy the 2 year notes, instead of the 13 week bills?

Let’s do a little back of the napkin simulation.

If the 13 week bill rate continues to rise at the recent rate of 1.2% per year, then by the end of 2 years you would earn an average rate of around 3.3%.

But it’s likely that that “material adverse event” will occur during that period and the rate rise would slow or stop. The odds of achieving a 3.4% average yield over 2 years by rolling over 13 week T-bills are questionable.  But there’s a good chance that you could at least equal the return on the 2 year note purchased today.

So I’d wait before buying a 2 year note. My bet would be that we’ll be able to lock in a higher yield on 2 year notes a few months or a year down the road.

But should we try to lock down that 3% yield on the 10 year?

Here’s a look at the long term chart:


Many professional investors and pundits have turned bullish on the 10 year. They think that 3% is a ceiling in yields. Investment funds are buying heavily. Dealers are buying. There’s lots of demand. But it’s not enough to absorb all that supply indefinitely.

So the yield keeps hammering away at that 3% level. It has already broken one trendline dating back 37 years to the 1981 peak. It seems destined to soon hit the next trendline now around 3.25%. As the Treasury continues to pound the market with supply month after month, and the Fed keeps pulling money out of the system, bond yields should break out and go much higher. That trend is likely to persist until that “material adverse event.”

Bond yields are likely to continue rising, probably rapidly once the 10 year surpasses the recent peak of 3.15%. That’s a problem because bond prices move inversely to yields. Price falls as yield rises.  If you ever needed to access cash during that 10 year term, you might be forced to sell that bond at a loss.

So when faced with the question of whether to buy 10-year T-bills, I believe that the answer here is definitely “no.”

The bottom line for now is to buy short term T-bills, and keep rolling that paper over as it comes due.

We’ll keep an eye on the bond market for signs that it’s time to extend those maturities and buy longer term notes and bonds.

Sincerely,


Lee Adler

4 Responses to “With Interest Rates Rising, Consider These Low-Risk Stock Alternatives”

  1. Willaim P. Dunn IV

    Lee needs to get his terminology correct T-Bill are issued 3 & 6 month duration’s and 1 year. The treasury issues demonstration of Treasury notes 2-10 years at auction and a 30 Bond 4 times a year. There is no 2 t-bill nor 10 year t-bill . But what do I know as a man who spent 20+ in the Primary dealers markets. He is correct on rolling over 3-month T-bills over long dated note,s as I advise clients to do the same.

  2. William P. Dunn IV,
    In response to your comment about T-Bills stating that there is not a term of 13 weeks, etc. I included a snippet from Investopedia that states the terms of a T-Bill as you can read below. So, I guess that Lee did know what he was talking about with his terminology about the T-Bill and its terms of maturity.
    Understanding Treasury Bills

    T-bills are issued with terms of four, 13, 26 or 52 weeks. They offer investors the lowest yield of all government bond issues. Similar to zero-coupon bonds, T-bills are auctioned off to investors at a discount to par. The difference between par value ($100) and the discount price is what investors view as its interest payment.

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