For nearly a decade, the U.S. has enjoyed rock-bottom interest rates. In 2018-2019, interest rates just started rising again. However, the 2020 pandemic quickly reversed this trend. Now, the worst of the pandemic seems to be behind us. Inflation is also starting to hit its highest rates since the 1980s. Due to this, it looks like it might finally be time to prepare for rising interest rates. The Federal Reserve has announced plans to raise rates at least three times in 2022. Goldman Sachs analysts expect there could be as many as four, four quarter rate hikes. This article will examine how you can prepare for an environment of rising interest rates.
We will also take a look at some of the best stocks for rising interest rates.
What’s Going On With Rising Interest Rates
There’s an entire generation that’s unfamiliar with a rising interest rates environment. Since the 2008 Financial Crisis, interest rates have basically been at 0%. Right when they started to creep up, the COVID-19 pandemic happened. To prevent a crash in 2020, the Fed slashed rates. Now, to combat inflation, it looks like higher rates are finally here.
If you’re not familiar, there are plenty of different interest rates in the U.S. However, “the interest rate” usually refers to the federal funds rate. This is the rate that banks can charge each other to lend money overnight. It is controlled by the Federal Reserve. This rate has a huge impact on employment, growth and inflation. It also indirectly impacts other types of interest rates for mortgages, auto loans, credit cards, etc.
In general, lower interest rates encourage borrowing and growth. The Fed usually cuts rates when there is an economic crisis. The Fed slashed rates three times in the past 20 years. First, during the Dot Com bubble. Then, during the 2008 Financial Crisis. Most recently, during the coronavirus pandemic. Cutting rates is a strategy for stimulating the economy.
On the other hand, higher interest rates discourage borrowing and limit growth. However, they can also help control inflation. Inflation was incredibly high in the 1980s. The Fed raised interest rates to over 10% during this time. Since inflation is increasing now, the Fed is looking to increase interest rates. It’s a little bit of a balancing act.
The announcement of rising rates has already impacted the stock market.
Rising Interest Rates And Tech Stocks
In the past few years, there’s been a surge of newly public companies. This is mainly due to the popularity of SPAC investing. This led to a lot of exciting high-growth companies going public. Now, many of these stocks are down big. In fact, the number of Nasdaq stocks down 50% is almost at a record.
This isn’t necessarily because these companies are failing. It has more to do with the economic environment. Because interest rates are rising, investment firms are moving their money around. High-growth tech stocks are good for low-interest-rate environments. However, for rising interest rates, many investment firms prefer value stocks.
This massive dip in the Nasdaq has been a huge transition of money away from growth stocks and into value stocks. So what does all this mean for you personally? If you got crushed in tech stocks, should you sell? How can you prepare for what’s to come?
How Should I Prepare?
One quick thing to note is that nobody knows what’s coming. Economics isn’t an exact science. A lot of it also depends on the Federal Reserve’s decisions. Analysts can forecast these decisions. But they can never know for sure. The Fed could really change its mind at any moment. However, assuming the Fed does raise rates, there are a few ways that you can prepare.
- Deleverage – If you use leverage (borrowed money) this is a good time to wind down. If stocks continue to fall, leverage will turn a bad situation into a disaster.
- Choose a less aggressive strategy – There is a lot of uncertainty right now. Uncertainty leads to volatility. It might be best to limit your risk until this volatility blows over.
- Diversify – It’s also a good time to revisit this golden rule. Diversification is one of the best ways to protect your money.
Speaking of which, let’s examine a few ways that you can diversify your portfolio. Here are a few of the best stocks for rising interest rates.
Best Stocks For Rising Interest Rates
High-interest rates are generally bad for high-growth stocks. This is because many high-growth stocks don’t earn a lot of money (yet). Instead, they forecast high earnings in the future. Investors buy the stock now in hopes that the company will make a lot of money in the future. When interest rates are low, this is a good bet. However, high interest rates make other investments more attractive for investors. Namely, bank stocks, cash-rich stocks, and value stocks.
- Bank stocks – Bank stocks are generally considered a safe bet during rising interest rates. This is because banks earn money from charging interest. Remember that the federal funds rate can impact things like mortgages. A higher funds rate can lead to higher mortgage rates (among other things). This can lead to more profit for banks. A few good banks stocks are Goldman Sachs (NYSE: GS), Bank of America (NYSE: BAC) and Chase (NYSE: JPM).
- Cash-rich stocks – Companies with lots of cash on hand are another safe haven. To start, these companies have plenty of cash to stay afloat in case there’s a recession. Also, just like banks, they can also earn more interest on their cash investments. For example, Apple (Nasdaq: AAPL) has about $200 billion in cash on hand. Meta Platforms (Nasdaq: FB), Ford (NYSE: F) and Oracle (NYSE: ORCL) are other cash-rich companies.
- Value stocks – In general, investing in value stocks is better for rising interest rates than growth stocks. For value stocks, most major companies will do. For example, Dow Jones companies like Nike (NYSE: NKE), McDonald’s (NYSE: MCD) or Home Depot (NYSE: HD). These are companies that have been around for decades. They have proven business models, diversified income streams, and cash on hand.
If these three strategies don’t appeal to you, there’s another strategy you can try.
Buying The Long-Term Dip
One thing that I do want to point out is that this transition could also present an incredible opportunity. Lots of growth stocks are down 50%+ from their all-time high. However, as I mentioned, this isn’t due to any fault of these companies. For certain growth stocks, rising interest rates could create a once-in-a-decade buying opportunity. It could be like buying Google or Amazon in the aftermath of the Dot Com bubble.
If you pursue this strategy, be prepared for pain in the short term. There is no way to tell how far some stocks could fall. Just because a stock has fallen 70%, does not mean that it can’t fall another 70%. Proceed with caution and have your diamond hands ready!
I hope that you’ve enjoyed learning about what to do in an environment of rising interest rates! Please base all investment decisions on your own due diligence.