Interest RatesSubmitted by Destination Wealth Management on April 27th, 2018
Interest rates have edged upward as the 10-year Treasury hit 3%. Headlines announced doom and concern about the spike in rates as if this was a death knell for the economy, fixed income markets, and equity prices. We do not believe this is the case.
We believe interest rates were bound to rise after eight years of recovery from the financial crisis and is both expected and reasonable. Remember, we are still talking about very low rates on a relative historic basis and at this point inflation does appear in check.
History suggests that the rise in rates is most problematic if the spike is unexpected and the slope is extreme. At this point, we believe that the normalization of rates is likely to be a more gradual process. While rates could very well rise several times this year, that's a far cry from the meteoric increases we have seen in previous interest rate cycles.
We have looked carefully at what happens to economic growth, fixed income prices, and equity markets in periods of rising rate environments. The analysis suggest that as long as economic growth remains reasonable, interest rate increases are survivable from an investment standpoint.
The key factor to monitor is the health of the US economy combined with inflation. The sub factors that bear watching are unemployment rates, consumer and producer prices, and overall economic growth. Watching for clues about the health of the economy requires assessing many economic data points.
Currently, there is no indication of a snapback in significantly higher inflation. Earnings continue to be positive with many companies reporting favorable numbers exceeding expectations. Tax cuts certainly are having an impact on corporate profitability and we expect this to continue. Of course, tax reductions impacting the skyrocketing deficit certainly is something to be aware of and monitor.
We believe it makes sense to position fixed income on average with lower durations and have positioned portfolios accordingly for some time now. For an extended period of time it appeared as if rates would never rise and that shorter durations were a mistake that would simply result in lower overall yields. It's apparent now that moving to lower duration assets was a prudent move.
One might ask if it makes sense to move out of fixed assets completely and into cash. That's a timing call that's problematic particularly given the additional yield one loses moving away from zero duration assets. While it might seem obvious that the economy is strong and rates will continue to rise, no one can predict the future. Believe it or not there are some economists warning that economic growth is not as strong as it appears and the potential exists for a recession later this year.
Rate increases have impacted markets and this is not unexpected. There has been an impact on higher-yielding stocks. We believe, however, that over time dividend yields will provide meaningful boosts to these companies fortunes and will be reflected in demand by the market. It just takes time to play out.
We continue to examine data on a regular basis. We have made a number of adjustments over the course of the last six months and continue to adjust portfolio strategies as conditions merit. We will continue to do so.
If you have any questions about this information. Please let us know. Always happy to answer any questions you might have.