Raul G. from Minnetonka, MN asks: I have seen different advice on what to do when interest rates rise. I’m curious if you have an opinion on how investors should adjust their portfolio if the Fed continues to raise interest rates, and if interest rates in general start to go up. Does it change the kinds of stocks to own? Are some types of fixed income better than others in this scenario? I appreciate your thoughts.
Mitch’s Response: Thank you for writing, Raul. Before I dive into some details I want to be clear on one thing: rising interest rates alone, in our view, should bear little influence on the asset allocation decision.
Here’s what I mean by that: if based on your long-term goals, your risk tolerance, your investment time horizon, and other factors, we decide that you should be allocated 70% to stocks right now, that decision does not change if even interest rates start to creep up. It will only change as your personal financial situation changes, or if we see something drastic happening in the capital markets. If you read my columns regularly, you will know that we remain optimistic about the outlook for stocks from here so we wouldn’t see a major catalyst for major portfolio shifts.
Looking at the fixed income world from a more macro standpoint, there are a few things to note as it relates to the Federal Reserve. Rate increases should be slow and gradual, but from the looks of it, the Fed is planning to run off $6 billion in Treasuries and $4 billion in mortgage backed securities per month (starting next quarter perhaps), and increase them on a quarterly basis until they reach $30 billion and $20 billion per month respectively. This unwinding means that a major buyer of U.S. government debt is starting to step away from the table, leaving a fairly large void in its place. Demand from international investors remains strong, but those institutions do not have the same gravitas as the Fed. If the balance shifts, we may finally start to see some upward pressure on the long end of the yield curve (10-year and 30-year US Treasuries). That, in our view, makes a strong case for favoring corporate bonds and municipals over Treasuries.
On the corporate bond side, it has been a solid start to the year, and in the back half it is possible that returns may come more from coupon payments than price appreciation, but we think it still makes sense to own high quality corporates within a fixed income allocation. The S&P 500 saw its best quarterly (Q1) earnings growth rate since 2011, and we still expect corporate earnings to grow by close to 10% for 2017, in aggregate. That should support positive performance from corporate bonds.
Though these are two areas of fixed income we generally like, it is important to stress that what we would recommend to you specifically, depends on your particular situation. There is no “cookie cutter” solution at Zacks Investment Management. The same would apply for stocks. Right now, with a solid 2017 earnings season posted so far, we see a lot of strength across sectors and are advising our clients to maximally allocate to stocks to the extent that their goals and risk tolerance allow. If you were looking for insight in particular to rising rates, we like Financials stocks if the long end of the yield curve rises faster than the short end. A steeper yield curve means banks’ net interest margins on loans go up, which is good for business.
As we reiterate the importance of knowing what your particular financial situation is, you may be wondering how do you determine your long-term goals, your risk tolerance, your investment time horizon and other factors. This can be a difficult process to navigate on your own. So, to help you get a head start, I would recommend referring to our guide, “4 Steps to Managing Your Retirement Assets.” This guide offers insight to help you make critical decisions about your retirement and outlines four simple steps that can give you an added advantage when you retire. Download your free copy today by clicking on the link below. Additionally, if you would like to talk with one of our wealth management advisors directly to get deeper insights into your current situation feel free to call us at 1-800-701-9830.