October 6, 2022

  • The Federal Reserve raised rates by another 75 basis points, bringing the federal funds rate above 2.5%.
  • The consumer price index in August was 8.3% compared to the previous year.
  • Three investment experts say bonds, CDs and dividend-paying stocks are good portfolio adjustments.

It is not news that the economy has entered a phase of slow growth and rising rates.

On Wednesday, the Federal Open Market Committee raised rates by another .75 basis points, bringing the total rate above 2.5%. The newly projected Fed funds rate is now 4.4% for 2023 and 2024.

Meanwhile, the August consumer price index, a measure of changes in prices of goods and services overtime, reached 8.3% year-on-year.

During a panel discussion hosted by Investopedia on Tuesday, Christine Benz, director of personal finance at Morningstar, pointed out that most fund managers have not seen these economic conditions during their careers.

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 fall simultaneously, she added.

In response, investors tend to make a big mistake when trying to adjust their portfolios to the crisis: They look at what has done well recently, said John Reckenthaler, vice president of research at Morningstar.

“I had a lot of 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 must have been an element of the barn door closing after the animals got out, because I looked at it and the commodity index is down 15% since mid-June, which would be pretty embarrassing if someone got in there in mid-June to hedge against rising inflation and perhaps even sold assets that had already lost money.”

Benz noted that Morningstar has reams of data showing that investors often undermine their own investment success by chasing what has recently outperformed.

It’s best to look at what you already have in your portfolio and go for the stuff that’s been beaten up the most, Rekenthaler noted. One example could be high-yield bonds, he added.

Benz acknowledged that the bonds provided a good cushion to offset capital losses in previous bear markets. She admitted that this time it is the fixed income part of the investor’s portfolio that worries them.

However, there are alternatives, says Anastasia Amoroso, managing director and chief investment strategist at iCapita. She especially points to a period of one to three months certificates of deposit (CDs) yielding rates not seen since 2005. Additionally, US Treasuries yield 4% for one to three years. On the spectrum of credit risk, where the risk increases, you can get returns of 8.5 percent, she noted.

“By the way, when yields are above 8%, the old adage is to buy it because once yields fall and spreads tighten, that ends up being a pretty good return for high-yield investors,” Amoroso said.

When it comes to stocks, those who have been investing since 2009 are used to the zero interest rate policy, Amoroso said. Since then, the term “buy the dip” in growth stocks has become a popular manual. Now it is difficult for investors to reconsider that approach, she added. What worked in the zero interest rate policy environment probably won’t work in the future, she added.

As rates continue to rise, investors need to become more discerning about what they are buying into. Going forward, not all rising stocks deserve it, Amoroso added.

“The environment we’re in is not one where non-yielding stocks can do well, but they are stocks that have either solid cash yield or a solid business model and are priced accordingly,” Amoroso said.

One thing that surprised her was that ETF flows were positive. She specifically pointed to those tied to dividend-paying stocks, such as the iShares Select Dividend ETF, which gives exposure to broad-cap U.S. companies with a consistent dividend history. Morningstar rating for The ETF has four stars. It has a 12-month trailing yield of 3.02%.

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