What do Rising Rates Mean for Investors?
With the surging economy and the recent shift in monetary policy, many investors are worried about rising interest rates and potential inflation. A little historical information can provide valuable perspective.
The chart below shows the impact of rising rates on various investments over the past 45 years. This period encompasses 12 times when the interest rate on the 10 Year US Treasury Bond rose at least 1.0%. The median rate increase was 1.7% and the median cycle lasted 14 months.
MEDIAN ASSET CLASS RETURNS IN RISING INTEREST RATE ENVIRONMENTS (1971 - 2012)
Returns are annualized. Real Estate = REITs, US Stocks = S&P 500 Index, Global Stocks = MSCI ACWI, Commodities = S&P GSCI Index | Source: Global Financial Data, Morningstar, Compustat
Rising interest rates are often a sign of a growing economy and increased consumer demand, both of which are positive for earnings and growth-oriented assets. The underlying fear is that inflation will continue to increase, which will prod the Federal Reserve to tighten monetary policy, which in turn will put the economy into a recession.
Current rates are still near historical lows and well below long-term averages. Inflation is also below its long-term average. The likelihood of inflation and interest rates suddenly spiking above long-term averages is extremely low. A gradual return to more normal conditions is a much more likely scenario. Looking at the fundamentals, economic and corporate earnings growth remain strong.
Common sense goes a long way here. When rates are high, invest in long-term bonds and lock in high returns. When interest rates are low, avoid long-duration fixed income due to the loss in principal as rates rise to normal levels. Historically, stocks and a broad-basket of commodities are the best hedge against inflation.
From the Behavioral Viewpoint
What is going on?
- Due to the ultra-low rate environment, even small rate increases result in significant declines in the value of fixed income investments. This is a real concern for managers and holders of these investments. Amplified by the media, every rate movement seems like an all-encompassing event. This creates availability bias with an overreliance on more recent information.
- After a long period of low inflation, initial increases can trigger memories past periods of hyper-inflation and the associated economic turmoil. These peak-end memories, viewing an event based on the extreme and final observations of a related past occurrence, can distort perceptions of current events.
- The marketplace has institutionalized notions, such as bonds for preservation and income or 60/40 percent asset allocation. These translate into familiarity bias and herding with broad market adoption. While good for cookie cutter solutions and large-scale companies, they are not always well-suited to an individual’s unique circumstances and current market conditions.
What can we do?
- Use needs-based planning to build solutions that match your needs and time horizon. Allocate resources towards liquidity, income and long-term growth needs.
- Beware of fixed-income investments and the associated rate risks. Look to cash for liquidity and preservation. For income consider alternative investments such as dividend paying stocks, real estate and MLPs.
- Look past the headlines and avoid reliance on the media and market pundits. Instead, work with a financial advisor who can provide valuable experience, coaching and perspective.
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IMPORTANT INFORMATION AND DISCLOSURES
The information provided here is for general informational purposes only and should not be considered an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. It should not be assumed that recommendations of AthenaInvest made herein or in the future will be profitable or will equal the past performance records of any AthenaInvest investment strategy or product. There can be no assurance that future recommendations will achieve comparable results. The author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions. AthenaInvest disclaims any responsibility to update such views. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of AthenaInvest.
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