January 31, 2023

  • The Federal Reserve raised rates another 75 basis points, bringing the fed funds rate above 2.5%.
  • August’s consumer price index came in at 8.3% year-on-year.
  • Three investment experts say bonds, CDs and dividend-paying stocks are good portfolio combinations.

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 overall rate above 2.5%. The new projected Fed funds rate for 2023 and 2024 now sits at 4.4%.

Meanwhile, August’s consumer price index, a measure of overtime price changes for goods and services, came in at 8.3% year-over-year.

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

The closest period paralleling this environment is the 1970s, when high inflation was accompanied by rising interest rates, causing stocks and bonds to decline simultaneously, he added.

In response, investors tend to make a big mistake when trying to adjust their portfolios to a recession: looking at what’s been performing well recently, says John Reckenthaler, Morningstar’s vice president of research.

“I had several people write to me in April, May, June talking about products, product funds, [and] Should I have more products in my portfolio?” Reckenthaler said.

He continued, “At least in that case, there must have been an element of bolting the barn door after the animals had gone out because I’ve seen it and the commodity index is down 15% since mid-June, which would be rather unpleasant for someone there in mid-June to hedge against rising inflation.” went and even sold assets that had already lost money.”

Benz points out that Morningstar has data showing that investors often discount their own investment success by following recent outperformers.

The best thing to do is look at what’s already in your portfolio and move toward the things that have taken the biggest beating, Reckenthaler points out. An example could be high yield bonds, he added.

Benz acknowledged that bonds have provided a nice cushion to offset equity losses during previous bear markets. He admits that at this point, the fixed income portion of investors’ portfolios is what worries them

However, there are alternatives, says Anastasia Amaroso, managing director and chief investment strategist at iCapita. He specifically points out Duration of one to three months Certificates of Deposit (CDs) are yielding rates not seen since 2005. Additionally, US Treasuries are yielding 4% over one to three year periods. On the credit risk spectrum, where risk increases, you can get an 8.5% yield, he noted.

“However, when the yield is above 8%, the old adage says you should buy it because once the yield drops and compresses, it can be a pretty good return for high yield investors,” Amoroso said.

When it comes to equities, those who have been investing since 2009 have become accustomed to the zero interest rate policy, Amaroso said. Since then, the phrase “buy the dip” has become a popular playbook in growth stocks. Now, investors are having a hard time rethinking that approach, he added. What worked in the zero interest rate policy environment probably won’t work going forward, he added.

As rates continue to rise, investors need to be more prudent in terms of what dips they buy. Going forward, not every growth stock is worth buying, Amaroso added.

“The environment we’re in is not one where stocks without yield can perform well, but it’s stocks that either have a solid cash flow yield or a solid business model and are priced accordingly,” Amoroso said.

One thing that has surprised him is that ETF flows have been positive. He pointed specifically to dividend-paying stocks, such as the iShares Select Dividend ETF, which provides exposure to broad-cap U.S. companies with a consistent history of dividends. Morningstar’s rating for this ETF four stars. It has a 12-month trailing yield of 3.02%.

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