For most of 2022, the financial markets have been bleeding red ink, driven by rising interest rates, high inflation, and recession fears.
The Federal Open Market Committee, the policy-making arm of the Federal Reserve, raised interest rates by another 75 basis points to a target range of 3 percent to 3.25 percent following its two-day meeting on Sept. 21.
Based on the language coming out of the central bank and the comments made by officials in recent weeks, the rising-rate climate is here to stay until inflation shows signs of coming down.
But the Fed’s tightening campaign is weighing on stocks and sending the U.S. dollar and Treasury yields higher. The leading benchmark indexes are down across the board, with the Nasdaq Composite Index in a bear market.
Overall, the rate hikes that have occurred since March have hurt investment portfolios, shedding several trillion dollars from 401(k)s and individual retirement accounts (IRAs).
According to a study published last month by J.P. Morgan Wealth Management, 88 percent of investors remain concerned about climbing inflation and rising interest rates.
As interest rates continue to remain elevated, how can investors prepare their portfolios for this type of economic landscape?
Differentiate Between Sectors
When trying to recalibrate an investment portfolio that acclimates to the new environment of rising interest rates, it might be best to begin differentiating between the best and worst sectors.
The top-performing sectors in a high-rate environment are real estate investment trusts (REITs), utilities, energy, and consumer goods, according to Robert R. Johnson, finance professor at Heider College of Business, Creighton University. On the other hand, the worst-performing markets are typically automobiles, durables, apparel, and retail.
According to Nick Reece, a portfolio manager at Merk Investments, the defensive sector, from utilities to consumer staples, have enjoyed “relative market strength.”
“In the initial market drawdown from the beginning of the year to the mid-June lows, energy was the only sector that was up, and health care, consumer staples, and utilities were down the least,” he wrote in a note on Sept. 21. “The same has been true in the recent decline from the mid-August interim high.”
The financial sector will typically do well when interest rates are high or low. If rates are high and credit demand is robust, consumers might pay more to borrow from these lenders. If rates are low, consumers will have greater access to credit, using it to fund large purchases, allowing banks to earn interest in larger volumes. Plus, banks will generate better revenues from fees, service charges, and commissions.
Speculative growth stocks may be passe following the pandemic-era boom. For many traders, balance-sheet investing is the new normal, as investors concentrate on cash-rich firms that possess low debt-to-equity ratios or businesses that hoard a lot of cash. These companies have refrained from taking on too much debt compared to over-leveraged businesses. Therefore, cash-flow stocks will not be as vulnerable to interest-rate shocks.
It is no secret that conservative investors are attracted to utilities during bull and bear markets. This is because utility stocks offer a hedge during highly volatile times and provide an income through handsome dividend yields. Although utilities will compete with bonds during a rising-rate market, they are still a smart way to pad your investment portfolio with security.
Cash Is King?
It also might be beneficial to explore various asset-allocation options when rates are higher, says Lyle Solomon, a personal finance expert and advisor. This could include zero-risk conventional vehicles.
“A rise in interest rate means that bond and commodity prices may fall, stock market losses, and higher interest rates on savings accounts, certificates of deposit, and money market accounts,” he told The Epoch Times. “You must explore the asset-allocation options. Use different systems and outcomes to decide whether to reallocate or leave your portfolio alone.”
According to the Federal Deposit Insurance Corporation (FDIC), the national average interest rate on savings account stands at 0.17 percent annual percentage yield. Online banks offer clients higher interest rates than the national average.
Beware Precious Metals?
When inflation is as high as it is, many investors have turned to safe-haven assets gold and silver as hedges. However, year to date, gold and silver prices are down 8 percent and 19 percent, respectively. But why? It has to do with the U.S. dollar and the Treasury market.
The U.S. Dollar Index (DXY), which gauges the greenback against a basket of currencies, has rallied more than 15 percent year to date, to a 20-year high of 111.00. The dollar has surged on both its safe-haven appeal and the Federal Reserve raising interest rates. But this is bearish for the metals market, because it makes dollar-denominated commodities more expensive for foreign investors to purchase.
A rising-rate environment will also lift the opportunity cost of holding nonyielding bullion.
Basic Financial Habits
Outside of the financial markets, personal finance experts purport that the most reliable strategy is to maintain a fiscally conservative attitude toward money. Whether it is spending within your means or saving regularly, being more responsible with your money is perhaps the best coping mechanism for a rising-rate climate.
With debt becoming more expensive, paying off credit cards and loans can be imperative, too.
“Another financial habit that can benefit in times of rising interest rates is to make your debt a priority,” Solomon explained. “When interest rates rise, the market rate for consumer debts rises, too. Loans that have a fixed rate remain unchanged, but variable-rate loans become more expensive. Under such situations, you should go for a fixed rate. That way, you can get a lower interest. And you should always focus on paying down high-interest rate debts like credit card debt first.”
Indeed, the effects of higher interest rates could be seeping into the overall economy as more consumers “reshape their purchasing priorities,” according to a new report from Morning Consult.
“In contrast with earlier this year, when spending pullbacks were primarily concentrated among discretionary goods, discretionary services were among the categories where spending was reduced in August as consumers grew increasingly cost-conscious,” the report stated.
Now that the U.S. economy and financial markets likely will have to contend with rising interest rates for another year, investors, consumers, and businesses must adapt. So, as a result, it might perhaps be a matter of resetting portfolios and adjusting to the new economic landscape.
“While there may be potential opportunities in those sectors that have historically outperformed as the Fed began hiking interest rates, sector leadership is likely to be very erratic as the Fed works to force back the strong surge in inflation. If you do make adjustments to your sector allocations, consider keeping them small—no more than a few percentage points,” Charles Schwab said in a report.
In the meantime, perhaps the most effective coping strategy, Johnson avers, is to refrain from timing the market and instead employ a dollar-cost average approach—frequently buy stocks at any time and at any share price—and maintain strong financial habits.