Safeguard Your Portfolio Against This Huge Risk

Few things about the state of the global economy seem certain these days. Between surging commodity prices, market crashes and rebounds, central bank interventions, sovereign debt crises, and political and social unrest in the Middle East, the past three years should have strongly reinforced the need to own a portfolio of investments with the ability to survive broad-market fluctuations. With the flames from the financial crisis mostly smothered, and the economy slowly improving, many of the most crucial macroeconomic questions seem resolved. However, a few major pitfalls might still upend the unprepared investor's portfolio -- especially interest rate risk.

In evaluating your portfolio for potential vulnerability to surging rates, you'll want to examine your holdings' potential downside and upside risks. You'll stand the best chance of beating the market if you avoid stocks that higher rates will hurt, and own stocks with the strength to survive even the harshest investment landscapes.

One especially risky sector
Mortgage REITs -- that's short for real estate investment trusts -- make their money by borrowing at short-term rates to buy real estate-related securities. They use the proceeds from their purchases to run the business and pay dividends to shareholders. The government allows these entities to pay no income tax, so long as they pay out more than 90% of their income as dividends to shareholders.

Low-rate environments allow these companies to load up on debt to easily finance their operations. However, higher interest rates should certainly apply greater pressure to these companies' massive payouts. If that scenario proves true, mortgage REIT companies like Chimera Investment and Annaly Capital Management could encounter serious headwinds. In fact, both Annaly and Chimera recently cut their dividend payouts, suggesting that my grim scenario might happen sooner than expected.

An interest rate-proof investment
On the flip side, stocks that stand the best chance of thriving with higher rates should have strong balance sheets, established businesses, and have a healthy history of profitability, even during trying times. In this regard, well -known but still cheap blue chips look like they have what it takes to weather any market condition, while retaining sufficiently attractive valuations to make them worthwhile investments today. Here's how a few major players stack up in several key metrics:

Company Name

Market Cap (in billions)

P/LTM Diluted EPS (before extra)

Dividend Yield (%)

Cash & ST Investments (in billions)

Total Debt / Equity (%)

Johnson & Johnson (NYSE: JNJ  ) $163.8 12.5 3.59% $37,658 29.6%
Microsoft (Nasdaq: MSFT  ) $216.6 11.0 2.5% $36,559 20%
Chevron (NYSE: CVX  ) $219.5 11.5 2.66% $17,070 10.8%
Intel (Nasdaq: INTC  ) $106.1 9.81 3.72% $21,885 4.66%
ConocoPhillips (NYSE: COP  ) $116.9 10.5 3.31% $11,521 41.4%
Royal Dutch Shell (NYSE: RDS-A  ) $233.3 10.8 4.56% $13,444 29.6%
AstraZeneca (NYSE: AZN  ) $66.8 8.22 5.34% $12,550 39.4%

Source: Capital IQ, a division of Standard & Poor's.

With extremely favorable debt burdens and ample, almost excessive, cash waiting in the wings, these companies won't bat an eye when interest rates increase. Better yet, they offer tempting valuations and payouts right now. You'll get a safe and attractively priced stock today, while helping to ensure that your portfolio stays afloat in case times grow worse.  

Smart investors always move proactively to benefit from changes as they occur. The last three years saw interest rates reach their lowest levels ever, and have yet to budge much since. Clearly, they have only one direction to go: Up! The Federal Reserve's easy-money policies brought plenty of contention when originally introduced. Now, given some of the comments issued recently by Fed members, rates may rise sooner than many observers expect.

A normal rate environment won't return overnight. However, a return to higher rates seems more of an inevitability than a possibility. Rest assured -- when those rates do rise, you'll want to make sure your portfolio's prepared.

Click here to add the companies mentioned above to My Watchlist.

Intel, Johnson & Johnson, and Microsoft are Motley Fool Inside Value selections. Chevron and Johnson & Johnson are Motley Fool Income Investor recommendations. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended diagonal call positions on Intel, Johnson & Johnson, and Microsoft. The Fool owns shares of Annaly Capital Management, Johnson & Johnson, and Microsoft. Motley Fool Alpha LLC owns shares of Johnson & Johnson and Microsoft. Try any of our Foolish newsletter services free for 30 days.

Andrew Tonner holds no positions in any of the stocks mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 08, 2011, at 5:32 PM, vrbsroma wrote:

    If the interest rate were to go up too fast or too high, the interest rate we pay on our debt would pretty much bankrupt the country. Rather than pay even more of a percentage of GDP in debt, the rate is kept articifially low. What makes you think it will rise after three years of being depressed? Just because it's "a long time"? The amount of money being created in unprecedented. This is uncharted territory. Plus I have confidence that NLY and CIM management have a decent plan in place for rising rate environment. After all, they don't have to manage any properties like other REITs. They're a finance company pure and simple and make money on the rate spread between long and short term. Can you explain how this article does anyhting than pump blue chips that are already over pumped and well known? Are you just creating material?

  • Report this Comment On April 08, 2011, at 7:30 PM, TMFTheDude wrote:

    Thanks for the comment!

    I completely agree that we currently sit in the realm of "uncharted territory" as far as interest rates go. Regardless, I still think they'll increase and possibly faster than some expect. I think looking to the markets presents some pretty convincing evidence to support that.

    As far as our ability to service our debt goes, markets will tolerate high debt burdens so far as they see proactive debt-reduction measures taking shape I'll use Portugal for comparison's sake because they have been in the news recently and have a much worse economic on their hands than we at present.

    Portugal (currently asking for a bailout from the EU. Read: on the brink of bankruptcy NOW) successfully auctioned off 1-year notes paying 4-5% interest on the 6th. A couple years ago a bank CD could earn you this type of interest, making this far from an "extreme" borrowing cost in my mind. Of course, observers long expected this. Recently, Portugal made serious political headwinds to reduce spending, in a very visible way. It seems assuring lenders they return to fiscal responsibility goes a long way to reduce anxiety. I think recent U.S. posturing shows an increased desire to become more fiscally disciplined (look at today's budget resolution crisis for instance, political posturing aside) as well.

    Also keep in mind how much better an economic condition the U.S. has over Portugal: reserve currency status, stronger capitalist system, the ability to print as much money as we want. Despite our obvious flaws, it seems we should be able pay our bills even around historically normal rates.

    I think the growing levels of positive economic news also indicate the private sector seems more and more ready to function at above these life-support levels of interest. Corporations have much stronger balance sheets and more cash than in any time in the recent past.

    One final point, the European Central Bank also just raised its benchmark rate this week. This marks the first major developed country's (or however you want to classify the EU) to hike rates.

    The overall trend looks decidedly headed in the favor higher rates to me.

    If you disagree, please fire back!

  • Report this Comment On April 08, 2011, at 11:20 PM, xetn wrote:

    The country is already bankrupt. If we included the non-budet items (social security, medicare, fannie mae, freedie mac, and others), which exceed by some estimates of $100 trillion, that would make the US dollar worth even less than it is today. You can see the results of QE1,and II reflected in the dollar price of gold, silver, oil, corn, wheat, cotton, copper, etc. We (the Fed) has flooded the world with dollars created out of thin air and the result is high levels of price inflation.

  • Report this Comment On April 09, 2011, at 11:33 PM, DoubleXero wrote:

    Whole Foods is another good target. 20% debt/equity. ~$400m cash. Increasing net income and dividend.

    People don't stop eating because of inflation & with Whole Foods having a generally affluent customer base (my perception) I think its setting pretty.

  • Report this Comment On April 10, 2011, at 12:40 AM, EllenBrandtPhD wrote:

    Motley's constant hatchet job attempts aimed at NLY and CIM are becoming comical.

    First of all, these are institutional stocks, and institutions don't get BOO'ed very easily.

    Second, the MREIT group is about to become hotter than hot with PIMCO's entry into the fold.

    Any reader who wants to know what is about to happen could start with this link:

    http://www.reuters.com/article/2011/04/08/markets-stocks-ipo...

    IMO, PIMCO's entry into MREITs is especially good for NLY and CIM, which have long wanted to keep their popularity among funds specializing in high yield vehicles, while paying slightly lower yields.

    CIM and NLY often rank numbers one and two among the top holdings of these sorts of funds, which are already very popular among money managers catering to high net worth individuals.

    PIMCO, being PIMCO, wants to get into MREITs, but it is not going to pay 14 percent for the privilege of doing so. I doubt they'll want to pay more than 10 percent, maybe less.

    So NLY and CIM may now be able to move their yields down to 11 or 12 percent, rather than 14, and still compete successfully with PIMCO.

    That will help NLY and CIM in terms of both profitability going forward and share appreciation, which has been hard to come by at 14 percent yields.

    Meanwhile, PIMCO's entry gives true credibility to the MREIT Model and establishes it as a bona fide asset class, which should become even more popular.

  • Report this Comment On April 11, 2011, at 11:11 AM, TMFTheDude wrote:

    More evidence of possible rate increases:

    http://online.wsj.com/article/SB1000142405274870484340457625...

    Key quote: "The strengthening outlook is causing economists to push up their predictions for when the Federal Reserve will begin raising interest rates."

    Keep the comments coming!

  • Report this Comment On April 25, 2011, at 10:48 AM, JimonSummerhill wrote:

    I agree, higher rates are coming. I think giant energy companies are a reasonable place to put assets.

    I do disagree with your selection of pharmas. J&J are the gang who can't operate, and AZN is losing 5 blockbusters over the next few years. I'm selling them to buy ABT.

    Intel has a decent dividend policy, but MSFT is "where money goes to die", with an employees over stockholders policy of buying stock and then handing it out as options, while maintaining a cash horde & low divs.

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