By: Steve Smith
This morning’s data showed that inflation is picking up at its fastest pace over two years and is on pace to hit the Fed’s 3% target. This means the Fed is likely to adhere to its planned pace for 3 more interest rate increases this year. Today’s investing advice explains the implications of these rate hikes.
Investors have been worrying about a rising rate environment for a few years now. What would it do to their bonds, and how would a normalization in rates affect stocks? The jury is still out, but so far so good.
From July 2016 through February 2018, the ten-year treasury rate rose from 1.37% to 2.94%. Over this 19 month period, a broad basket of bonds (BND) fell 2.13%. Fortunately, stocks more than made up for this, rising 33% over the same time. Since rates began their ascent in February 2016, a 60/40 portfolio rose 19%, or 11.7% on an annualized basis.
Bonds fell 2% over the past nineteen months; Stocks fell 2% four times in the past twelve sessions.
The chart below shows the rolling 30-day standard deviation of a 60/40 portfolio broken down between stocks and bonds. Over the past 20 years, 86% of the volatility of a 60/40 portfolio has come from stocks.
Also, the reality is that the current situation is a boon for most long term investors. For those who need a balanced portfolio with some fixed income, they should be cheering for higher rates in order for the bond portion of their holdings to generate income.
While there might be a short-term drop in the value of both stocks and bonds, over the long term higher rates will lead to higher returns. The best investing advice for traders right now is to focus on the long haul, and make choices that take advantage of coming rate hikes.