Markets in a Minute
How Rising Treasury Yields Impact Your Portfolio
This infographic is available as a poster.
This infographic is available as a poster.
How Rising Treasury Yields Impact Your Portfolio
Since the start of 2021, the yield on the U.S. 10-year Treasury note has climbed to pre-pandemic levels. But what exactly does this mean, and how could it impact your portfolio?
In this Markets in a Minute from New York Life Investments, we explain why Treasury yields are important and which investments may go up or down when yields are rising.
What are Treasury Yields?
Treasury yields are the total amount of money you earn from U.S. debt securities, such as bonds and T-bills. Yields depend on both the security’s price, relative to its face value, and its “coupon” or interest payment.
The 10-year yield is important because it is closely-watched indication of market sentiment. Here’s what leads to changing Treasury yields:
- When investors expect the market to drop, they look for safer investments.
- Due to higher bond demand, prices rise.
- This lowers their yield, as bonds become more expensive than they were before.
The opposite occurs when the market is bullish.
- When investors expect the market to rise, they look for riskier investments.
- Due to less bond demand, prices drop.
- This raises their yield, as bonds become more cost effective.
Currently, Treasury yields are in the latter scenario because investors are confident in a sustained recovery as vaccines are rolled out and the economy reopens.
Investments That May Go Up During Rising Yields
Rising yields can have a number of knock-on effects in the market. Here are the investments that could increase in value when yields are going up.
| Investment | Why could returns potentially increase? |
|---|---|
| U.S. dollar | Rising yields attract income-seeking investors, who must purchase U.S. debt in U.S. dollars |
| Savings accounts | If the economy is growing at a rate that may lead to hyperinflation, the central bank may raise interest rates |
| REITs | While rising rates pose challenges, economic growth typically translates into a higher level of real estate demand |
| Cyclical stocks | Stocks that move with the economy, like banks, tend to do well during economic recoveries |
Cyclical stocks, such as banks, travel, and energy, may all benefit from an economic recovery. This is particularly true for banks if the economy is growing at a rate that exceeds inflation targets, as the central bank may raise interest rates. In turn, this allows banks to earn a higher profit margin because they can charge a higher rate on their loans.
While it is commonly said that real estate investment trusts (REITs) underperform during rising interest rates, the data tells a different story. In four of six periods of sustained rising yields, REITs earned positive returns—and they outperformed stocks in half of them.
Source: S&P Dow Jones Indices
Rising rates do pose challenges, including higher borrowing costs and lower property values.
However, it’s evident that rising rates also have a positive influence on REITs. For instance, rising rates are typically associated with economic growth, which translates to higher real estate demand and higher occupancy rates. This means REITs can see increased earnings and dividends.
Investments That May Go Down During Rising Yields
On the flip side, there are some investments that could decrease in value when yields climb.
| Investment | Why could returns potentially decrease? |
|---|---|
| Bonds | To remain competitive, newly issued bonds offer higher interest rates—making existing bonds less attractive |
| Dividend-paying stocks | Rising rates give an edge to newly issued bonds, creating a historically safer alternative for income-seeking investors |
| Gold | As a safe haven asset, gold is less desirable during market optimism |
| Some growth stocks | Rising interest rates make borrowing more expensive, which may slow company growth |
Existing bonds will likely see declining performance, with higher volatility among long-term government and corporate bonds. Short-term bonds typically see smaller drops. This is because they have less interest rate risk: there’s a smaller probability that interest rates will rise before a short-term bond’s maturity, and they have fewer interest payments that could be affected by rising rates.
Growth stocks, such as those in the technology sector, may also see weaker performance. In fact, value stocks have been outperforming growth stocks since the fourth quarter of 2020, a significant shift from growth’s strong historical performance in recent years.
U.S. Treasury Yields: One Part of the Picture
In addition to being a barometer for investor confidence, Treasury yields can have an important impact on your portfolio.
However, investment performance can vary depending on a number of other economic factors such as inflation and interest rate levels. For example, climbing inflation could lead to higher gold prices, since gold is seen as an inflationary hedge. You may want to consider the full economic picture when you are reviewing your portfolio.
Markets in a Minute
Explainer: A Visual Introduction to Fed Tapering
Broadly speaking, Fed tapering is the reversal of quantitative easing. We show the history of Federal Reserve bond tapering and how it works.
Explainer: A Visual Introduction to Fed Tapering
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The Federal Reserve began tapering its large-scale asset purchases in November 2021, a move likely influenced by:
- Rising inflation
- Improving unemployment
- Strong U.S. GDP growth
More than $4 trillion in capital was injected into the economy through quantitative easing (QE), over the course of the pandemic, inflation is at 40-year highs, and unemployment levels hover below 4%.
As Fed policy responds to a recovering U.S. economy, this Markets in a Minute chart from New York Life Investments shows how Fed tapering works, and its impact on the economy.
How Fed Tapering Works
Fed tapering is the unwinding of the Federal Reserve’s large-scale asset purchases.
After the 2008 financial crisis, large scale asset purchases were introduced for the first time to inject liquidity into the market and help restore confidence. During the pandemic, they were introduced once more, at a rate of $120 billion per month.
Here’s how it works:
- The U.S. central bank buys government bonds typically in the form of Treasuries and mortgage-backed securities (MBS).
- This influx of demand leads to a rise in these bond prices and their yields (interest rates) fall.
- As this lowers the interest rate on the government bonds, what often follows is lower interest rates on loans for households and businesses.
- Lower rates stimulate spending.
- When the economy is running well, the bank may unwind asset purchases to help keep inflation low, otherwise known as Fed tapering.
Notably, Fed tapering and QE is hotly debated among economists. Those in favor say QE is a critical tool for stimulating the economy. Those against say that it inflates asset prices and contributes to inequality.
Inflation Levels
The consumer price index (CPI) rose 7% in December, the highest rise since 1982.
Given this increase, Lawrence Summers, former U.S. Treasury Secretary and Jason Furman, former chief economist for President Obama say that the Fed didn’t taper soon enough. Other financial heavyweights suggest this is just the beginning of a hawkish approach to inflation.
So how does Fed tapering impact inflation?
By tapering asset purchases, the amount of money circulating in the economy that can be used to borrow to buy a house or car is reduced. According to this theory, when there is less spending, inflation will gradually cool down.
Fed Tapering and Interest Rates
The Federal Reserve has outlined that it will taper asset purchases before it increases targets on short-term interest rates. By current estimates, interest rates could rise in March.
However, if the pandemic takes a turn for the worse, the Federal Reserve can shift direction. This gives the Fed time to assess how the market and economy will react before it raises rates.
To prevent the taper tantrum of 2013, which led to market volatility and U.S. dollar appreciation, Federal Reserve chair Jerome Powell has stated that the Fed must carefully communicate the sequence of QE and tapering to prevent any fear in the market.
When Doves Cry
Like the 1940s, the rise in money growth over the pandemic has been driven by government deficits. By contrast, leading up to the 2008 Global Financial Crisis or during the 1950s and 60s, the private sector spurred loan growth.
Monetary inflation can impact consumer prices and financial asset inflation.
As CPI and financial markets have soared over the pandemic, investors will be watching closely to see how Fed tapering impacts future monetary policy.
Markets in a Minute
Ranked: Real Estate Returns by Property Sector (2012-2021)
From residential to retail, are there patterns in real estate return on investment? We rank them by sector over the last decade to find out.
This infographic is available as a poster.
Real Estate Return on Investment by Sector
For the ninth year in a row, Americans say real estate is the best long-term investment.
However, what might be less clear to the average investor are the different types of investments available within the real estate sector, and how they compare. Real estate return on investment within property sectors has historically been uneven, and 2021 was no exception. While residential property soared, office real estate has performed relatively poorly.
Are there any patterns in the top performers over time?
This Markets in a Minute from New York Life Investments ranks real estate return on investment by sector over the last decade.
Sector Returns Over Time
We used data from the National Association of Real Estate Investment Trusts to show real estate return on investment by year. A real estate investment trust is a company that owns, operates, or finances income-producing real estate.
Here’s how total returns stack up by property sector, sorted from highest to lowest return in 2021.
| 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | |
|---|---|---|---|---|---|---|---|---|---|---|
| Self Storage | 19.9% | 9.5% | 31.4% | 40.7% | -8.1% | 3.7% | 2.9% | 13.7% | 12.9% | 57.6% |
| Residential | 6.9% | -5.4% | 40.0% | 17.1% | 4.5% | 6.6% | 3.1% | 30.9% | -10.7% | 45.8% |
| Industrial | 31.3% | 7.4% | 21.0% | 2.6% | 30.7% | 20.6% | -2.5% | 48.7% | 12.2% | 45.4% |
| Retail | 26.7% | 1.9% | 27.6% | 4.6% | 1.0% | -4.8% | -5.0% | 10.7% | -25.2% | 41.9% |
| Diversified | 12.2% | 4.3% | 27.2% | -0.5% | 10.3% | -0.1% | -12.5% | 24.1% | -21.8% | 20.5% |
| Infrastructure | 29.9% | 4.8% | 20.2% | 3.7% | 10.0% | 35.4% | 7.0% | 42.0% | 7.3% | 18.6% |
| Timber | 37.1% | 7.9% | 8.6% | -7.0% | 8.3% | 21.9% | -32.0% | 42.0% | 10.3% | 16.4% |
| Mortgage | 19.9% | -2.0% | 17.9% | -8.9% | 22.9% | 19.8% | -2.5% | 21.3% | -18.8% | 14.7% |
| Office | 14.2% | 5.6% | 25.9% | 0.3% | 13.2% | 5.3% | -14.5% | 31.4% | -18.4% | 13.4% |
| Healthcare | 20.4% | -7.1% | 33.3% | -7.3% | 6.4% | 0.9% | 7.6% | 21.2% | -9.9% | 7.7% |
| Lodging/Resorts | 12.5% | 27.2% | 32.5% | -24.4% | 24.3% | 7.2% | -12.8% | 15.7% | -23.6% | 6.3% |
Data for 2021 is as of November 30. Specialty and data center sectors are excluded as this data was only available from 2015 onwards.
Self Storage real estate was the best performing sector for the last two years, and also performed well during the 2015 market correction. It tends to perform well when people’s lives are disrupted, such as when they’re moving for a new job, schooling, or due to marriage or divorce. In the case of COVID-19, self storage got an extra boost from people wanting more space in their home amid remote work.
Timber and Industrial real estate have been in the top three performing sectors for at least half of the last decade. Industrial real estate, a category including properties that enable the production, storage, and distribution of goods, has seen increased demand due to the rise of e-commerce. One estimate says the U.S. could require an extra billion square feet of warehouse space by 2025.
On the other hand, the Lodging/Resort sector has frequently been one of the bottom performers. A form of discretionary spending, hotel stays may be one of the first expenses people cut when the economy is in a downturn. This weakness was compounded by lockdown restrictions during the COVID-19 pandemic.
What is a Good Return on Investment in Real Estate?
In light of the above data, investors may be wondering which sectors are “the best” to invest in.
The short answer: it depends. Here’s how real estate return on investment has varied within sectors, using the minimum, median, and maximum returns. We’ve sorted the data from the highest to lowest standard deviation, a measure of risk.
While Timber and Self Storage have delivered strong returns, they have also been relatively risky, with some of the widest variations in returns.
Industrials have seen the highest median return, and their risk is about middle of the pack. The second highest median return goes to the Mortgage sector, which earns income from the interest on mortgages and mortgage-backed securities. The mortgage sector has seen less risk than most other real estate categories, at least in the last decade.
For investors with a lower risk tolerance, Infrastructure may be a sector to consider. These properties had a positive return on investment for all of the last 10 years, and had the lowest risk of any property sector.
Patterns Within Real Estate Return on Investment
By looking at historical patterns, investors can consider how economic conditions may affect real estate return on investment.
Sectors associated with discretionary spending, such as Retail and Lodging, have tended to perform poorly during downturns. On the other hand, Self Storage and Residential properties have historically been more resilient during the 2015 selloff and the COVID-19 pandemic.
Future trends may also offer food for thought. For example, as the population ages and the government puts an increased focus on critical facilities, could the Healthcare and Infrastructure sectors be poised for growth?
Whichever sector(s) an investor focuses in on, real estate serves as an alternative investment that can help diversify any portfolio.
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