RETIRE ON TRACK: Putting the relationship between interest rates and stocks in perspective

After a generation of historically low interest rates, we’re finally seeing sustained increases to fight inflation. And in mid-June the Federal Reserve System’s Federal Open Market Committee announced an increase in its benchmark rate of three-fourths of a percentage point – the largest increase in 28 years.

After the announcement the federal funds rate, which is the interest rate that banks and depository institutions loan money to each other, stood at 1.75%. This increase will generally raise our borrowing costs as well, and we can all agree that today’s higher interest rates are unpleasant. But a little historical perspective might help reframe the situation. We’re still a long way away from the whopping 20% in 1980, when the country was suffering from 13.5% inflation. We’re also still below the 2% to 5% rate the Fed targets.

In theory, higher interest rates should hurt stock prices. If it costs more to borrow, we buy less stuff like homes and autos, which could hurt company revenues and hinder growth plans. Rising rates also might make low-interest instruments like CDs somewhat more attractive. If interest rates keep increasing some experts believe five-year CD rates could hit almost 5% by the end of 2023, compared with rates in the 0.30%-0.40% range earlier this year.

But the reality is less certain. Dow Jones recently studied the effect of interest rate increases on the stock market, using data going back to 1989, and found that the S&P 500’s return was an average of almost 63% during periods of Fed rate hikes. That might be because, historically, the Fed raised rates to cool off the economy. Note that stocks also tended to increase during periods of Fed rate decreases, although the average gain was less than during rounds of rate increases.

I’m not sure that history should be a good guide for our current situation, however. We haven’t seen inflation like this for quite some time, and there doesn’t seem to be any long-term relief around the corner. Energy inflation, accounting for 9% of the consumer price index, was almost 35% in May, the highest level since 2005. And we’re still amid a tenuous situation with the pandemic, which played havoc with the economy and hampered the supply chain.

So stocks might suffer this time from interest rate hikes and inflation, but there always opportunities in the market. Warren Buffett, in a 1981 letter to shareholders, explained succinctly what types of companies to look for in an inflationary environment: ones that can raise prices easily without fear of losing a lot of market share or volume, and ones that can handle a lot more business with only minor additional investments of capital. So, for example, think about companies selling those must-have products with a loyal customer base.

As for the rest of your portfolio, you should discuss moves to make in an environment of higher interest rates with your adviser. Depending on your individual situation, you might have options in bonds and real estate, for example.

Evan R. Guido is the founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com. Read more of his insights at heraldtribune.com/business. Securities offered through Avantax Investment ServicesSM, member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, insurance services offered through an Avantax affiliated insurance agency. 8225 Natures Way, Suite 119, Lakewood Ranch, FL 34202.

This article originally appeared on Sarasota Herald-Tribune: EVAN GUIDO: Despite interest rates, inflation, opportunities exist