- The Federal Reserve hiked rates by another 75 basis points, bringing the fed funds rate above 2.5%.
- August’s consumer price index came in at 8.3% year-over-year.
- Three investing experts say bonds, CDs, and dividend-paying stocks are good portfolio adjustments.
It’s not news that the economy has entered a stage of slow growth and rising rates.
On Wednesday, The Federal Open Market Committee hiked rates by another .75 basis points, bringing the overall rate above 2.5%. The newly projected Fed funds rate now sits at 4.4% for 2023 and 2024.
During a panel discussion hosted by Investopedia on Tuesday, Christine Benz, the director of personal finance at Morningstar noted that most fund managers haven’t seen these economic conditions during their career span.
The closest time period that parallels this environment is the 1970s, when high inflation was accompanied by rising interest rates, causing stocks and bonds to simultaneously drop, she added.
As a response, investors tend to make a big mistake when attempting to adjust their portfolios to the downturn: They look at what’s recently been performing well, said John Rekenthaler, vice president of research at Morningstar.
“I had quite a few people writing to me in April, May, June talking about commodities, commodity funds, [and] should I have more commodities in my portfolio?” Rekenthaler said.
He continued, “At least in that case, there was certainly an element of bolting the barn door after the animals went out because I looked it up and the commodity index is down 15% since the middle of June, which would be rather unpleasant if somebody had gone in there in the middle of June for protection against rising inflation and maybe even sold assets that had already lost money.”
Benz noted that Morningstar has reams of data showing that investors oftentimes undermine their own investment success by chasing what has recently outperformed.
The best thing to do is look at what you already have in your portfolio and move towards things that have been beaten up most, Rekenthaler noted. One example could be high yield bonds, he added.
Benz acknowledged that bonds provided a nice cushion to offset equity losses during previous bear markets. She acknowledged that this time around, the fixed income portion of investors’ portfolios is what’s worrying them.
However, there are alternatives, says Anastasia Amoroso, the managing director and chief investment strategist at iCapita. She specifically points to one to three-month term certificates of deposits (CDs) which are yielding rates that haven’t been seen since 2005. Additionally, US Treasuries are yielding 4% on the one to three-year terms. On the credit risk spectrum, where risk increases, you can get yields of 8.5%, she noted.
“By the way, when yields are above 8%, the old adage says you’re supposed to buy that because once yields fall and spreads compress, that ends up being pretty good returns for high yield investors,” Amoroso said.
When it comes to equities, those who have been investing since 2009 have become accustomed to a zero interest rate policy, said Amoroso. From that, the term “buy the dip” on growth stocks became a popular playbook. Now, investors are having a hard time rethinking that approach, she added. What worked in an environment of zero interest rate policy is likely not going to work going forward, she added.
As rates continue to rise, investors need to become more discerning in terms of what they’re buying the dip on. Moving forward, not every growth stock deserves to be bought, Amoroso added.
“The environment that we’re in is not one where stocks without yield can perform well, but it’s stocks that have either a solid cash flow yield or a solid business model and are priced accordingly,” Amoroso said.
One thing that has surprised her is that ETF flows have been positive. She specifically pointed to those pegged to dividend-paying stocks, such as the iShares Select Dividend ETF, which gives exposure to broad-cap US companies with a consistent history of dividends. Morningstar’s rating for the ETF is four stars. It has a 12-month trailing yield of 3.02%.