How To Survive The Post-Rate Hike Apocalypse

Stéphane Renevier

3 months ago3:00 mins

How To Survive The Post-Rate Hike Apocalypse

The US Federal Reserve raised rates for the second time on Wednesday – this time by the most since the middle of 2000. And with the central bank saying outright that it’d be committing to these hikes for some time, we’re past the “Will they? Won’t they?” stage right now. That leaves you with a big question hanging over your head: how to position your portfolio from here on out. Let’s take a look.

What changed for investors this week?

Surprisingly, not much. Sure, the Fed did ease some market fears of an even more aggressive hiking cycle, saying it will raise interest rates as gradually as possible. That’s somewhat reassuring. But, let’s not kid ourselves, with inflation still above 8%, the Fed has to hike rates aggressively to bring inflation back closer to its 2% target.

The Fed may have softened its message, but the facts haven’t changed, and the Fed funds rate is going to keep heading higher. That’s probably why markets reversed their gains the day after the Fed meeting: investors realized nothing had fundamentally changed.

And that’s a worry for the economy. Higher interest rates not only impact consumers' budgets (making payments higher on mortgages, personal loans, and so on) but they also impact companies’ growth and profits (through higher financing costs for example), and eventually those things slow the economy down.

The Fed seems hopeful that it’ll manage to slow the economy just enough and bring down inflation without leading to an economic recession – achieving what’s called a “soft-landing”. But historical evidence shows it’s unlikely: only once has the Fed managed to hike rates and avoid a recession in the process.

So how should I position my portfolio now?

Hold some cash, obviously.

Make sure you hold at least some cash in a rainy-day fund. That will not only reduce your losses should markets tank, but will also allow you to profit from the opportunities that arise.

Buy defensive stocks

While valuations have come down and sentiment has reached extreme negative levels, a lot of investors are still hanging on. (In finance terms, we’d say, the market hasn’t seen a real “capitulation” yet.) Stocks are down just 14% from their all-time highs, after all, and they could fall further. So favor defensive sectors (need-to-have things like healthcare, utilities or consumer staples) over more cyclical ones (nice-to-have things like tech, travel or consumer discretionary). For your individual stock choices, favor more mature, quality businesses over younger and riskier ones. If possible, go for high and stable dividends, and cheap valuations for a better margin of safety. Some ideas here: Buffett’s top stocks, high dividend stocks, and utilities.

Dip your toe into US Treasury bonds.

Sharply rising rates and high inflation are causing US Treasuries to suffer their largest losses in decades. But at some point, higher rates will slow down the economy, and eventually tame inflationary pressures. At that point, investors are likely to expect the Fed to cut rates (in fact, they’re already starting to expect that), which will be positive for the price of longer-term bonds. The timing might be a bit early, but starting to add Treasury bonds to your portfolio should bring some balance to your portfolio and improve its long-term risk/reward profile. iShares 7-10 Year Treasury Bond ETF (ticker: IEF, expense ratio: 0.15%) and the higher octane iShares 20+ Year Treasury Bond ETF (ticker: TLT, expense ratio: 0.15%) are both good options to include US Treasury bonds to your portfolio.

Make sure you own some commodities.

Compared to stocks, commodities are more resistant to higher interest rates and inflation, and they currently benefit from favorable supply and demand dynamics. That being said, they wouldn’t be immune to a significant slowdown in growth, which would lower their demand and their prices. The abrdn Bloomberg All Commodity Strategy K-1 Free ETF (ticker: BCI, expense ratio: 0.25%) is one of the most efficient ways to play that view, as it’s cheap and diversified.

Owning some gold separately is also probably a good idea, as it arguably remains the best hedge against a more extreme stagflationary scenario (low growth and high inflation). You can buy gold for a very low fee with the abrdn Physical Gold Shares ETF (ticker: SGOL, expense ratio: 0.17%).

Buy the US dollar to hedge your portfolio.

The US dollar has risen a lot, but it arguably remains your best hedge against the possibility that stocks, bonds, and commodities fall all at the same time, which could happen if higher rates tip the economy into a recession. Having a small, tactical position in the USD might prove to be worth its weight in gold when it comes to diversifying your portfolio. You can implement it via CFDs (possibly against high-risk currencies like the AUD or NZD if you want to make it even more defensive), or through the Invesco DB US Dollar Index Bullish Fund (ticker: UUP, expense ratio: 0.78%).

/1 Your free monthly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.