The Federal Reserve and other central banks have announced plans to raise interest rates. Just the mere hint of this has sent stock markets gyrating wildly in January.
It has not been pretty to put it mildly but with inflation rising each month globally, was the announcement of rate increases actually a surprise? No, it is long overdue but it will arrive with unintended consequences to your investment portfolio.
The Federal Reserve along with other "central planners" have fueled massive bubbles in several asset classes with the ultra-long bear market in interest rates. Low rates have become expected; so many think that they will never rise, or if they do not by much, so they have positioned themselves accordingly with growth stock, high yield bonds and crypto. Well it was a nice ride but it looks like the low rates party is winding down. So how do you position yourself for the coming hangover? Well, let's start by discussing debt levels for everyone, including nations.
The biggest cracks are seen in low grade (junk) bonds issued by emerging markets and companies. Currently there are 74 low income countries that must repay $35 billion to lenders in 2022. This is up 45% from 2020. Interesting that this time period coincides with the pandemic, so tracking the COVID narrative may well mean we have seen the bottom for bond yields. During the same two years we have seen demand destruction in oil (followed by a predictable rebound), the great resignation (also predictable after paying people to stay home and telling them that it is OK not to pay their bills), and supply chain issues (caused by globalization which was, you guessed it, predictable). Add environmental, social, and governance (ESG) mandates and virtue signaling and we are still mired in pandemic chaos.
So what's an investor to do you ask? Go back to fundamentals and look for current earnings and actual value.
This year is looking especially sweet for the much-hated fossil fuel companies, many who pay juicy dividends. With oil near $90 per barrel, oil companies can buy back shares and raise dividends all day long. If you are thinking "oil has already run up a lot," ask yourself, if the demand for oil is going away any time soon? The answer is no and since these companies have been so unloved by institutional investors and have not plowed money back into exploration, the existing oil supplies will need to be sufficient for current and future demand and they are not. Now if you are thinking, gee Carol, are you not aware that clean energy will replace fossil fuels soon, so why not buy a Tesla instead? I give a “high 5” to all those brave souls who bought Tesla a few years ago but Tesla like other growth companies relies on cheap money to thrive and that dynamic is now changing. So is competition in the EV space as we have all been informed (I'm waiting for mandated) by our government that we must own an EV soon whether we want one or not.
If you are thinking you prefer not to fuel climate change with your investment choices that's OK too. Start looking for companies with low debt, rising demand for product or service, low P/E and a history of raising their dividend. Keep in mind while shopping for stock that whatever companies you buy, they must be able to not just survive but thrive in a higher interest rate/inflation environment. Oh, and please remember that whatever crazy idea I come up with also comes with a disclaimer to do your own research before buying anything and diversify your holdings to limit sector risks.
Just a follow up note. Worried friends and neighbors have been inquiring about if it is time to reallocate their investments. If you are asking yourself this now, it's a bit late but as interest rates rise (this is as close to a sure thing as the sun setting in the west now) please talk to a good adviser or make changes yourself. There is nothing, I repeat nothing wrong with holding cash right now. Your money does not have to be fully invested. And if you own junk bonds, you many want to run for the hills, the walls of the house of pain are crumbling around you.
