Markets have been on a seesaw of uncertainty related to the Federal Reserve’s monetary policy on interest rates, as the central bank attempts to wrangle a stubborn inflation rate down to its target of 2%. The CME Fedwatch tool, a barometer for bond traders’ expectations for interest rate cuts at the Fed’s future policy meetings, shows that most don’t anticipate a rate cut until September at the earliest.
Each new labor and consumer report that comes through Wall Street is scrutinized for an indication as to the health of the economy and a direction on rates. Meanwhile, the price of gold and other metals, sometimes seen as inflation hedges or defensive investments, have surged at the same time that the S&P 500 has been pushing up all-time highs. The 10-year Treasury yield has pulled back to about 4.4%, and the yield curve has been persistently inverted, as some speculate that it’s losing its reliability as an economic indicator of recession.
In short, there are a lot of mixed messages on inflation and the economy flying around. So, understandably, investors in the markets have questions. To address some of these hot topics, we asked the financial advisors and investing experts who write for the U.S. News Advisor’s Corner series to weigh in on some of the most popular questions from internet searches now about inflation and give their thoughts on the direction investors should take in today’s market climate.
Reader question: Why is inflation so high?
KATE STALTER: The rise in inflation in the past couple of years is due to several factors, including increased demand, supply chain disruptions, rising energy costs and labor shortages.
JULIE PINKERTON: Yes, while inflation has come down significantly from its high, it has hit a roadblock due to rising fuel prices and persistently elevated housing prices, including both mortgages and rent. As a result, the Federal Reserve has put the brakes further on interest rate cuts for now. Should these costs become more affordable, the Fed will evaluate when they can resume key rate cuts.
SCOTT WARD: The U.S. Bureau of Labor Statistics’ release of the consumer price index, or CPI, data for March was unwelcome news for many investors. The March CPI increased 3.5% over the prior 12 months. What roiled investors even more, though, was the fact that CPI figures also steadily grew in January, up 3.1%, and February, up 3.2%. Still, there were some stubborn contributors to the CPI uptick in March (shelter, gasoline). The CPI report indicated that combined, “these two indexes contributed over half of the monthly increase in the index for all items.” But the PCE, or personal consumption expenditures price index, is the Fed’s preferred benchmark and has been a little less “sticky” so far this year.
U.S. NEWS: Although the April CPI data released May 15 showed that inflation cooled slightly, increasing 0.3% from March, prices still rose 3.4% year over year. Core inflation rose 3.6% on an annual basis, however, the slowest pace in three years.
Should I hedge my portfolio, or will inflation come down?
KATE: Savvy investors always allocate their portfolios to address the effects of inflation in retirement. And because inflation erodes spending power, investing in stocks remains a proven way to generate the return you’ll need to maintain your lifestyle in retirement.
MARGUERITA (RITA) CHENG: Investing in (certain) equities can mitigate the risk of higher interest rates and higher inflation. Companies that can increase prices without sacrificing demand for their products and services are less vulnerable because they are perceived as having pricing power.
How do interest rates impact the stock market?
SCOTT: Typically, there’s an inverse relationship with interest rates and market swings. Lower interest rates tend to encourage borrowing among consumers and companies, which can lead to an increase in spending and, by extension, an upswing in asset prices. Take intermediate bonds, for example. Following the last five rate-hike cycles from 1995 to 2019, intermediate bonds have bounced back by an average one-year return of 11.55%, according to data from Hartford Funds and Bloomberg …
RITA: And, generally speaking, when interest rates increase, businesses and consumers will decrease spending. As a result, earnings and stock prices may be negatively impacted. An increase in interest rates also increases the cost of borrowing money. When interest rates decrease, consumers and businesses may feel more comfortable borrowing money and increase spending, which may positively impact stock prices.
Is it likely the Fed will cut interest rates soon?
SCOTT: In a panel discussion at the Wilson Center on April 16, Fed Chair Jerome Powell cautioned that sticky, elevated inflation will likely push off any Fed rate cuts until later this year. Currently, the CME FedWatch tool, which is a go-to gauge for many investors and analysts, anticipates two Fed cuts this year, beginning in September.
JULIE: It may take a bit, especially as new pressures on the supply chain have arisen.
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Is it smart to sell when interest rates are high?
KATE: This is a case of the answer being that very unsatisfying phrase, “It depends.” Higher interest rates affect stock-price valuations because companies face greater challenges when borrowing money. Higher rates also put pressure on the present value of future cash flows. However, if earnings are rising, which has been the case in various sectors recently, institutional investors frequently continue to buy up shares on optimism about stocks’ future performance.
SCOTT: A key question is, What type of market return do you need in support of your financial goals in the coming years? If you will likely need access to your funds for a big-ticket purchase within the next five years, then you may want to consider stable options, such as a money-market fund, a bank certificate of deposit or a Treasury note. Otherwise, if your time horizon for a financial goal is longer than five years, such as for retirement, then your patience and discipline may be rewarded; for example, currently, PGIM’s 10-year estimate for a balanced allocation of 60% equities and 40% fixed income is 6.25%.
JULIE: With the daily news filled with stories about inflation rising again in 2024 and the Federal Reserve halting further interest rate cuts, many investors start becoming nervous. Each investor’s situation is different, so it is important to evaluate if you will need funds in the near future or if your portfolio has a long enough horizon to stay the course. This is the time that a professional financial advisor can be a great value in making pragmatic changes versus having an emotional reaction.
KATE: Yes, and investors using a tactical approach to asset allocation generally rebalance or reallocate more frequently than investors using a strategic approach. Either way, be sure your portfolio allocations are done with your long-term goals in mind, rather than being knee-jerk reactions to inflationary conditions.
RITA: I would agree that it’s important to consider both your personal and financial circumstances and the economy when determining which asset to sell. A note on bonds is that there is an inverse relationship between bond prices and interest rates. In other words, interest rates and bonds often move in opposite directions. When rates rise, bond prices usually fall, so it may not be appropriate to sell bonds at a loss.
What are the best investments right now?
KATE: For long-term investors, the best investments align with their goals, time horizon and risk tolerance. If you’re intrigued by a particular stock or sector or asset class, such as cryptocurrencies, one approach is to hold it outside your portfolio allocation and treat it like “fun money.” That way, if it fizzles, it won’t damage your retirement allocation. But if it takes off like a rocket, you’ll have some extra cash.
JULIE: It’s true that an investor’s time horizon is so critical to answering this question. For example, if near-term liquidity will be important, an investor may want to lock in high interest rates with certificates of deposit, money market accounts and high-yield savings accounts.
RITA: Higher interest rates do increase borrowing costs, but higher interest rates on high-yield savings accounts, money market accounts and CDs are the highest they have been in a while. As Julie and Kate said, your risk tolerance, time horizon and your goals help guide the appropriate mix of savings and investments. If you need money for an emergency fund, down payment on a car or home, a wedding or another upcoming expense, consider high-yield savings accounts, money market accounts or a CD ladder.
JULIE: Longer-horizon investors need to assess whether they are seeking growth or desiring to reduce volatility. Also, some investors that are able to buy real estate without requiring a mortgage may be able to capitalize on the rental market surge.
RITA: If your time horizon is longer term, like 10-plus years, consider including any of these in your portfolio: cybersecurity, robotics and AI, advanced life sciences, or gene and cell therapies.
Should I invest in gold? I know it recently hit all-time highs.
JULIE: In times of great uncertainty, gold definitely becomes a popular topic at dinner parties! With high inflation and geopolitical unrest from the multiple global hotspots, the price of gold has indeed risen to all-time highs. When gold is popular, the metal dealers are able to command excessive premiums. Most investors find physical gold to be a more attractive diversification tool when they are able to make regular purchases and not attempt to time the market. Clients who need greater flexibility can also purchase gold through ETFs and gold mutual funds.
RITA: Investing in gold can help hedge against inflation. For example, as inflation increases, the real purchasing power of your dollars decreases. If you have stashes of cash, while your cash isn’t subject to market fluctuation, your cash is subject to inflation risk.
KATE: Precious metals, like all commodities, should be part of an investor’s portfolio, although not the main component. Gold and other commodities can serve as a hedge against stock market volatility and can help smooth returns.
RITA: Right, and as with any asset class, diversification is key. Investors may want to include gold and/or other commodities in their portfolio because they provide diversification. The investment performance of gold is correlated with the stock market during risk-on periods, but its performance can be inversely correlated during periods of economic and global uncertainty. Another tried-and-true rule to long-term wealth accumulation is to buy low and sell high. The amount you decide to allocate to gold should be based on your unique personal and financial situation.
It’s clear from the advisors’ responses that no matter the market climate, an informed, dispassionate approach to investing for the long term should be based on an individual investor’s need for liquidity, their time horizon, risk tolerance and an assessment of their existing holdings. The consensus seems to be that interest rate cuts are likely to happen later this year, but no dramatic buying or selling strategy is in order; in fact, staying the course with reliable equities and bond investments may be prudent. It’s also appropriate to allocate a small percentage of your portfolio to gold and alternative investments, or ensure diversification in some form, no matter what economic fluctuations are in store.
Should you play defense, or go for growth? The panel’s answers suggest that for long-term planning, as always, the answer is probably both, in moderation.
For more answers to commonly asked questions and common topics encountered by the advisors, visit Advisor’s Corner.
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Inflation Dilemma: Should I Play Defense or Go for Growth? originally appeared on usnews.com
Update 06/04/24: This story was published at an earlier date and has been updated with new information.
