NEW ORLEANS — The smoking hot U.S economy is thawing out. The Nasdaq is down and inflation is up, but unfortunately you can’t invest directly in it.
Will the economy chill even more? Turn downright cold? Nobody knows for sure. But what we do know is that there are steps investors can take to protect portfolios in times of high inflation and rising interest rates. With the right planning, your portfolio can limit downside and even find pockets of upside in a cooling economy.
Here are a few tips:
- Ask your advisor about commodities. As the only broad category of investment that has been positive year to date, commodities continue to make money. Agricultural commodities such as soybeans and corn along with energy and oil and gas continue to have high consumer demand despite rising costs due to inflation and the stressed supply chain. Consider a 5% allocation of your portfolios in commodities.
- But don’t forget to consider political risks. Energy companies, like Exxon Mobile, are enjoying high prices for the oil they sell. But White House leadership concerned with climate change and other environmental issues may affect the value of energy stocks.
- Look for dividends. Seek out mature companies that are paying dividends, especially if they have a history of increasing those dividends. When the economy is hot and interest rates are low, people tend to be attracted to exciting new companies like Tesla or Facebook (now Meta.) But when the economy is cooling down, companies that are not heavily reinvesting into their businesses can give profits back to the company’s stockholders. Now is a good time to revisit old reliables such as IBM and Philip Morris International.
- Avoid debt-heavy companies. Companies with big loans will have bigger bills to pay as rates increase, making it harder for them to balance their budgets. Instead, look for companies with low debt that can maintain earnings with little investment. Some tech companies can fit that mold, especially if they have other features in this list.
- Look for companies with pricing power. Companies that have a strong market position and few competitors can raise prices as needed. One example is an MLP (Master Limited Partnership) pipeline, which basically moves oil from the well to distribution centers.
- Real Estate. Mortgage rates have risen off the bottom, yet remain near historic lows. Additionally, construction of new housing has trended under the rate of household formation since the financial crisis in 2008 so concerns of oversupply are mellowed. If you buy now and secure a fixed-rate mortgage, your monthly payments will stay at that level. For a $300,000 loan, every 1% increase means an extra $200 payment a month or an extra $2400 a year. Real Estate Investment Trusts (REIT) also deserve a closer look. Rising rents help battle rising rates. REITs have diversified in areas like data centers and cell towers, beyond the old retail and office sectors which are a lower slice of the market.
- Lean toward value equity and international equity asset classes. Tilting, not over-investing, in these areas during high inflation can be a smart idea. A recent Equitas study showed these asset classes perform better in times of higher inflation, perhaps because both categories start at lower price to earnings ratios than the S&P 500. History is no guarantee, but during periods of rising interest rates, we tend to see price to earnings ratios flatten out.
As the Fed raises the interest rates to counter the effects of inflation, the U.S. economy is sure to cool down. But with the right planning, you can make sure your portfolio remains hot even if the U.S. economy cools down.