Rising Interest Rates: Perspective for Investors

The low interest rate environment we’ve enjoyed since the Federal Reserve’s last rate increase in 2018 will begin to shift in 2022.

On March 16, the Fed increased rates by 25 basis points (0.25 percent), bringing it to .50 percent. The hike might have been higher, possibly up to 50 basis points, but the war in Ukraine, higher inflation with decreased consumer spending and slower supply chains have the Fed concerned about raising interest rates too fast and creating the beginnings of a recession.

While the Fed is forecasting seven rate hikes this year, some pundits still believe we will only see four or five, depending on future inflation readings. We expect these to be incremental, possibly .25 percent each time.

What does this mean for you and your investments?

Stocks

We’ve already seen a tremendous sell-off in the market. The S&P 500 Index is down so far in 2022, and the NASDAQ, too. Raymond James’ Director of Equity Portfolio & Technical Strategy, Mike Gibbs, recently altered his forecast for S&P’s year-end pricing to 4,725, down from his original estimate of 5,023.

Tech stocks are one of the sectors being hit the hardest because of the threat of rate increases. Purchasers have already shifted their focus from the once “high flying” tech stocks to more conservative, dividend-paying stocks.

A change in interest rates affects some of the newer and smaller tech stocks like Trade Desk (TTD), Shopify (SHOP), Snowflake (SNOW), etc. more than it would larger companies like Amazon (AMZN) or Meta Platforms (FB). That’s because smaller tech companies are big borrowers of money, so a rise in interest rates adversely affects their profit margins.

However, when smaller tech stock prices start to fall, there is unfortunately a spill-over into consumer confidence in the more-established companies, whose stock may be intrinsically solid. For example, according to a recent report released by CNN Business, consumer sentiment is down 59.7 points, the lowest level since 2011.

Currently, we’re seeing investors favor value stocks over growth stocks. Of course, we still believe in growth stocks for the long-term, but feel in the short-term, value stocks are going to be the better investment.

Something to always keep in mind is that dips in the stock market present great buying opportunities when you follow a “buy low, sell high” approach.

Bonds

Interest rates have been dropping over the last 38 years. With the Fed’s increase, we will slowly see rates start to rise again, affecting Treasury, municipal and corporate bonds yields. Already over the last 10 months, the 10-year Treasury yield has risen to more than 2 percent.

In our opinion, investors should look to buy individual bonds versus bond mutual funds. Owners of individual bonds will receive interest and their original investment if they hold the bond to maturity. By contrast, bond funds, which have no finite maturity, will be more negatively impacted in a rising rate environment.

A word of warning – the price changes will be a bit of a shock to individual bond holders. On paper, they will see the current market value of those bonds go down, but that value only pertains to their marketability if they were to be sold before maturity.

International Markets

With so much global upheaval right now, we are mostly avoiding international and emerging stock and bond markets. Europe will be more adversely affected by the current war in Ukraine and any future conflict in Taiwan because of their more interconnected supply chains and greater dependency on Russian oil, even more so than the U.S. All of this will ultimately take a bite out of discretionary spending for Europeans. And with the current uncertainty in China and the SEC’s delisting of some of their stocks, we are specifically avoiding Chinese investments.

In the Oakley Group investment models that we manage for our clients, we already decreased our international exposure back in January, and we’ll most likely look to decrease it again.

Real Estate

Rising interest rates can create a slowing of the real estate market, but with low current inventory and a decrease in the issuing of residential construction permits, it seems the demand will still continue for a while. The work-at-home culture is stronger than ever in many corporations, so we will see a slowing of commercial real estate. Therefore we would be very cautious about investing in REITs (Real Estate Investment Trusts) that are concentrated in that market.

Sam Oakley is a managing director with Pinnacle Asset Management and a financial representative with Raymond James Financial Services, Inc., member FINRA/SIPC. He can be reached at sam.oakley@pnfp.com or (615) 743-8999