This week's announcement by the Federal Reserve marked the end of a historic era of near-zero interest rates. For investors, it signals a shift to a rising interest-rate environment, which opens the door to a new phase of potential winners and losers.
The Fed boosted its key short-term interest rate -- the federal funds rate -- by 25 basis points to 0.25 to 0.50 percent, which is still low by historical standards. But the shift is positive news for the economy -- think of it as a vote of confidence that the economy has finally healed from the global financial crisis.
"The purpose of the rate increase is to move away from emergency accommodation that was put in place during the depths of the Great Recession," says Thomas Cassidy, senior vice president at Philadelphia-area Univest Wealth.
Rising rates mean the economy is getting better, says Ted Peters, former member of the Philadelphia Fed Board and CEO of the Wayne, Pennsylvania-based Bluestone Financial Institutions Fund. "It's that simple. It's a sign that things are certainly improving. If the economy continues to improve, the market will continue to go up."
This week's move is small in nature, but it's important for investors to recognize is that it is just the beginning. In 2016, economists expect the Fed to hike rates another three or four times, which could bring the federal funds rate to 1.25 to 1.50 percent by the end of the year. "We're projecting that there is going to be at least three increases in 2016, and each one will be around 25 basis points," Peters says.
Consumers can expect to see variable rates on their credit cards increase over the next one to two billing cycles, while banks likely won't be in a rush to boost interest rates on certificates of deposit.
If you are a borrower, you will see higher rates. "It took Wells Fargo (WFC) 12 minutes to raise the prime rate, but they didn't raise the deposit rate. As rates go up, there's going to be a lag effect. Banks will increase lending rates faster than they increase deposit rates," Peters says.
Here are seven moves investors can consider now:
Stay invested in stocks. For long-term investors saving for retirement or college expenses for their children, the rate hike doesn't necessarily spell the death knell for the current bull market. "We have a nice, slow-growing economy that is not overheated. We could see a continuation of the bull market for another two to three years," says Jeff Carbone, managing partner of Cornerstone Financial Partners in North Carolina.
Be selective about stock sectors. Consumer discretionary stocks are poised to outperform in a rising interest-rate environment. The consumer discretionary sector is a broad-based grouping that includes automotive, consumer electronics, retailers, restaurants and entertainment. "The economy is doing well, so consumers will be spending," Peters says. The financial sector could also benefit, especially banks that are asset-sensitive and boost lending rates faster than the rates that they pay to depositors, he says. Sectors to avoid include homebuilding and construction stocks, which are seen as sensitive to rising interest rates, especially if the Fed raises them faster than expected. Utilities are another sector that could underperform.
Beware of multinationals. The U.S. dollar index surged about 10 percent in 2015. Additional rate hikes could support further strength in the dollar, and that causes headwinds for big U.S. multinational companies that sell their products abroad. If a foreign customer is looking at Caterpillar (CAT) tractors, they might buy from Japanese maker Komatsu (KMTUY) instead. "Because their currency is lower, they will get a 20 percent discount on the Komatsu tractor," Carbone says. Investors looking to avoid the headwinds from a rising dollar can look to own companies that primarily sell goods and services domestically, such as companies in the health care sector.
Look at the middle of the yield curve. Bond investments are ranked short term, intermediate term and long term based on the time horizon of the security. In recent years, many investors reached out to longer-duration bond investments to capture a higher yield. Now may be the time to make a shift. "Most investors would think that the wisest investment move to make in your bond allocation is to shorten up your duration. However, we expect short-term rates to increase more than longer-term rates and would suggest that investors maintain an intermediate-term duration, around four-and-a-half to five years, in their bond allocation," says Thomas Cassidy, senior vice president at Philadelphia-area Univest Wealth. "We would suggest investing in a fund that is diversified and has exposure to Treasury bonds, government agencies and investment-grade corporate bonds. Diversified intermediate-term bond funds can be found at most major mutual fund companies, and given the low interest-rate environment, a low-cost bond fund is the best way to invest."
Consider exposure to international equities. As the Federal Reserve aims to increase interest rates several times in 2016, other major central banks like the European Central Bank and the Bank of Japan remain in an easing mode. "It is a good time to invest overseas. The ECB and BOJ are still in the midst of quantitative easing, which means their equity markets should show growth," Carbone says. Investors could consider an exchange-traded fund or mutual fund with international exposure that is hedged in U.S. dollars to benefit from the trend of rising international equities and rising U.S. dollars, he says. One fund that invests in European equities with a currency hedge is WisdomTree Europe Hedged Equity Fund (HEDJ).
Invest in real estate sooner rather than later. Rising interest rates will put upward pressure on mortgage rates. "I would buy real estate now instead of later because mortgage rates will be higher. That would be an asset class I'd look at," Peters says.
Prepare for market volatility. The stock market could see an increased level of volatility amid uncertainty over the pace and amount the Fed will hike rates. "It's almost like the Goldilocks story. There is too quickly, too slowly and just right," Carbone says. Investors who have appropriately diversified their portfolio are best-served by simply blocking out the news and turning the noise off.
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