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Your Toolkit for Rising Rates

Your Toolkit for Rising Rates

2015 could be the year we finally see rising interest rates in the U.S. This creates an opportunity to reassess portfolios and asset classes and evaluate how they performed during historical periods of rising interest rates. While the past can never guarantee the future, historical context is important for understanding a phenomenon that we really haven't seen in a longer-term trend for approximately 30 years.

Bonds vs. Stocks

The critical question here—as in many environments—is stocks versus bonds. By design, the fixed nature of bond interest payments creates a bit of a headwind as rates rise. On the other hand, rising interest rates usually occur in tandem with rising inflation, and stocks have historically grown their dividends at a level above that of inflation over long periods.1

Big Picture: To the extent that rising interest rates reflect rising growth expectations and rising inflation expectations, we believe that equities can see a tailwind and perform quite well over the medium to long term, even if U.S. Federal Reserve (Fed) activity (or inactivity) can cause some short-term volatility.

Further Distinctions to Be Made

Also here—as in many environments—it's not just stocks versus bonds, but types of stocks versus types of bonds.

Within equities, we wanted to look at three categories: large caps (the S&P 500 Index), small caps (the Russell 2000 Index) and high-yielding dividend payers (the Dow Jones U.S. Select Dividend Index). While this certainly doesn't exhaust all equity possibilities, it does provide an interesting cross-section of a few major categories—indicating how they reacted in different periods of rising interest rates.

Within fixed income, we examined the difference between a pure government bond exposure (interest rate risk, but not credit risk), a high-quality bond index and a high-yield bond index (less interest rate risk, more credit risk). Within equities, we looked at dividend-paying stocks. We'd expect higher-yielding dividend payers to face a headwind, while more growth-oriented companies could be better positioned to grow their dividends with rising interest rates and rising inflation.

We...


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