Rising Interest Rates And The Impact On Your Portfolio

Rising Interest Rates And The Impact On Your Portfolio

If you don’t think the specter of looming inflation is cause for concern, then Treasury Secretary Janet Yellen’s remarks on Tuesday might change your mind…

On Tuesday, in a pre-recorded interview at the Atlantic’s Future Economy Summit, Yellen commented:
 
“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat . . . “
 
Why is this significant? Because it flies in the face of what the Fed announced as its newly adopted approach to inflation last August.
 
The Fed announced in August that it would be making a major shift in its approach to inflation. Instead of focusing on inflation in light of setting interest rates, the Fed announced that it would begin placing more emphasis on employment – even willing to allow inflation to rise above its long-standing target of 2% to avoid cooling the economy to preserve jobs.
 
The Fed indicated it would likely keep rates low for the next five years. To highlight the magnitude of this policy shift, this reverses more than 40 years of policies that gave priority to the fight against rising prices.
 
The Fed’s new approach ushers in a new era of a shift from focusing on trying to act in advance of inflation based on its forecasts, to waiting until inflation actually arrivesThe problem with this approach is it’s never been tested.
 
What happens if inflation gets out of control, and by the time the Fed responds, it’s too late?
 
The historically long lag between the time a monetary policy move is put in place and its effect on the economy, as Milton Friedman emphasized, doesn’t instill confidence in the Fed being able to respond to inflation before it hits full bore.
 
Yellen’s remarks spooked the markets, sparking a minor sell-off in tech stocks and prompting Yellen to backtrack her remarks later in the day to contain the damage.
 
The push and pull between inflation and interest rates will be an interesting development to monitor in the coming months and years. Unfortunately, it’s a no-win situation for Wall Street investors as neither high inflation nor increasing interest rates are favorably viewed by an investing public – driven more by perception than reality when making investing decisions.
 
Rising interest rates will have a negative effect on portfolios heavily allocated to public equities. Stocks take a hit when interest rates rise for a couple of reasons.
 

  • First, rising interest rates are unfavorably viewed by the investing public whether the increase has had a direct impact on the economy or not. In other words, rising interest rates or even the threat of rising interest rates – as the Yellen episode this week demonstrated – spooks investors – causing them to sell off their holdings.
  • The second effect on the stock market from rising interest rates is more direct. As the interest rates rise, the cost of borrowing by both businesses and consumers rises. As a result, when consumers borrow less, they spend less. And when interest rates for credit cards and mortgages increase, consumers have less disposable income to spend. Both consequences directly impact public company bottom lines.

 
Businesses pay the price from rising interest rates not only from reduced consumer spending but because their own cost of borrowing goes up, the cost of running and expanding their operations goes up. This may result in cost reduction measures, including layoffs.
 
Buzz over inflation and rising interest rates will no doubt negatively impact a portfolio heavily allocated to stocks.
 
How do you shield your portfolio from rising interest rates?
 
Allocate Away From Wall Street
 
Allocate away from Wall Street towards recession and inflation-resistant assets. Invest in tangible assets with demand. There will always be a demand for life-sustaining essentials like food, medicine, and shelter.
 
Sophisticated investors have invested for demand for years to hedge against inflation, rising interest rates, and stock market volatility in general. Investing long-term in tangible assets that consumers will always need and demand – ones that even thrive during a downturn – are ideal for protecting a portfolio.
 
Investors who invest long-term in proven assets – even if other investors consider them boring – can block out the short-term stresses everyone else suffers through from the stock market and widespread economic volatility.
 
Proven long-term investments may take a short-term hit, but they have always demonstrated resilience and shouldn’t have any trouble overcoming any current or future crisis.
 
Don’t let rising interest rates spook you. Instead, protect your portfolio by considering alternative assets.

About The Author

John Turley
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