After 7 years of holding interest rates at zero, the Federal Reserve Board announced they will begin raising short-term interest rates. This signifies the beginning of the early rate hike phase, along with potential changes to the current allocation of the portfolios.
Expanded content is in the video link below.
Since 1994, the Federal Reserve raised rates from the floor a total of three times. Unfortunately, this provides very little data for what we can expect going forward. I have attached charts of the 3 months before, and the 9 months after each rate hike. The approximate day of the increase is marked in yellow on each chart.
What I want you to notice is while the market may have rallied in the short-term, within the following two months (or less) of the initial rate hike the market corrected. The market performed rather well after each of these corrections.
Historically, the market has dropped following an initial hike. However, this is not a reason to convert to cash or to panic. No one knows with certainty if the market will drop, how much it may drop, or how long it may potentially remain down.
Today, the biggest headwind the market faces is the rising dollar. As the U.S. dollar continues to appreciate against other currencies, it represents the biggest threat to equities today. Historically, stocks prefer a weak or weakening dollar.
In all three previous rate hikes, the dollar weakened or remained relatively flat in the months that followed. Things are likely to be different this time because the European Union, Japan and Australia are either engaged in a quantitative easing program, low interest rate policy or a negative interest rate policy. These policies generally support a weaker currency, thus giving the U.S. dollar the potential to move much higher.
I share this with you because much of the historic sector data and guides on how to invest in a rising rate market are all based on a weakening, not a rising U.S. dollar.
Currently, the good news is the equity allocation of the portfolios is tied to sectors that historically perform well during a rising dollar environment. I have done quite a bit of research in the past few months and will make minor adjustments to the equity portfolios going forward.
Further adjustments will be made to the bond portfolios to hedge against rising interest rates. Keep in mind as we go through this cycle that even when short-term rates rise, long-term rates can, and do fall. While the long-term trend line can be moving upward, rates are cyclical. For this reason, I may need to make more frequent adjustments to the bond portfolios.
In the months and years that follow this initial hike there will be many challenges, as well as opportunities. My commitment is to continue to share my research and to generate the best return I can within the risk profile of each portfolio model.