The chart below shows the impact of rising rates on various investments over the past 45 years. This period encompasses 12 times when the interest rate on the 10 Year US Treasury Bond rose at least 1.0%. The median rate increase was 1.7% and the median cycle lasted 14 months.
MEDIAN ASSET CLASS RETURNS IN RISING INTEREST RATE ENVIRONMENTS (1971 – 2012)
Returns are annualized. Real Estate = REITs, US Stocks = S&P 500 Index, Global Stocks = MSCI ACWI, Commodities = S&P GSCI Index | Source: Global Financial Data, Morningstar, Compustat
Rising interest rates are often a sign of a growing economy and increased consumer demand, both of which are positive for earnings and growth-oriented assets. The underlying fear is that inflation will continue to increase, which will prod the Federal Reserve to tighten monetary policy, which in turn will put the economy into a recession.
Current rates are still near historical lows and well below long-term averages. Inflation is also below its long-term average. The likelihood of inflation and interest rates suddenly spiking above long-term averages is extremely low. A gradual return to more normal conditions is a much more likely scenario. Looking at the fundamentals, economic and corporate earnings growth remain strong.
Common sense goes a long way here. When rates are high, invest in long-term bonds and lock in high returns. When interest rates are low, avoid long-duration fixed income due to the loss in principal as rates rise to normal levels. Historically, stocks and a broad-basket of commodities are the best hedge against inflation.
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