Say goodbye to 60/40 portfolio
Rule for stock/bond formula not just outdated, it’s “downright dangerous.”
The Fed just got 271,000 new reasons to boost interest rates. Investors had better get ready.
The door is wide open for the Federal Reserve to increase short-term interest rates when it meets in December following the report on Friday showing companies added 271,000 jobs in October. If the move in rates comes, it could signal a tectonic shift in the marketplace and prompt investors to tear up the playbook that has basically been printing them money the last few years.
Overnight, higher rates went from a coin toss to a very strong possibility. Futures markets now indicate there’s a 70% chance the Fed takes rates up in December, according to Bloomberg News. That’s up from Thursday when the implied odds of a rate hike were 56%. Savvy investors know it’s perilous to ignore pending moves by the Fed because higher interest rates can dramatically change the investment climate.
How much? The benchmark Standard & Poor’s 500 index has seen its average gain shrink to 2.4% in the six months following an initial Fed rate hike going back to 1971, says Sam Stovall of S&P Capital IQ. Compare that to the 9.5% average gain in the six months prior to hikes.
Some markets are already behaving like a rate hike is a foregone conclusion. Stocks that have been attractive during the period of practically zero interest rates are suffering now because investors figure the party is just about over. Utilities stocks were hardest hit Friday, with the Utilities Select Sector SPDR exchange-traded fund falling 3.7%. That’s the largest decline among the 10 sectors in the S&P 500. If interest rates rise, that makes the fat dividend yields traditionally paid by utilities relatively less attractive.
Similarly, real estate investment trusts, which have been hugely popular with investors because of their rich dividends, fell too. The Vanguard REIT ETF dropped 2.9%. Bond investors also felt the pain. The Vanguard Total Bond Market ETF lost 0.4%.
Things could be close to changing. Investors seem to think financials could be the winners. The ability to boost interest rates on loans — as long as demand remains strong — could lift bank profits. The Financial Select Sector SPDR is up 0.9% Friday, the best performer of the 10 industry sectors. But longer term, financial stocks have been laggards when the Fed starting to lift rates.
Playing this major market shift will keep investors occupied the next couple months as the Fed goes from background risk to front-burner concern. There will be places to make money, though.
Energy, consumer goods, food stocks and ultimately utilities wind up being the best areas for investors during periods of rising rates, says Robert Johnson, president of the American College of Financial Services and co-author of Invest with the Fed. Commodity prices also tend to be strong, due to increased inflation, which in turn helps emerging markets stocks. Many companies in emerging nations are closely tied to commodity prices.
But one thing is for sure. This is not the time to fight the Fed.