When an economy starts moving out of recession toward positive growth, investors are likely to have many questions about rising interest rates.
It’s unclear why investors assume that rising interest rates are nothing but bad news.
In summer 2013, the market saw its steepest decline in over a year – 350 points lost – simply because Federal Reserve Chairman Ben Bernanke suggested that the Fed’s program of quantitative easing will end at some point. Interest rates jumped on the news, and just about every asset class got punished: stocks, bonds, even precious metals.
Meanwhile, there is Florence, my elderly former client in New York City, who might finally get her wish that the banks would give her something better than a 0.05 percent return on her CDs. At the same time, some of her higher yielding municipal bonds are less likely to be called now.
The point is that one investor’s loss is often another investor’s gain. So who, besides Florence, stands on the winning side when interest rates rise? Certainly, holders of cash and short-term lenders do: They have the opportunity to reset their holdings at higher rates. Stock investors in companies with low or no debt are also likely to benefit. There’s also a positive correlation between higher U.S. interest rates and the value of the dollar. A rising dollar will generally favor importers of foreign goods and services, as well as net consumers of oil – i.e., the U.S. economy as a whole.
Which brings us back to the whole reason for the rising interest rates in the first place. Back in 2013, Bernanke’s announcement that the Fed will ease off monetary easing was based on the observation that the U.S. economy was on the mend and needed less artificial stimulus from the Fed. It was not so long ago that the prospect of economic growth, and the resulting increase in employment, would be occasion for a strong market rally.
So perhaps the real winners in these situations are those wise enough (or old enough, like Florence) to realize that higher interest rates are not an occasion to dump everything and run, but to selectively profit from a strengthening economy.