The Federal Reserve raised its benchmark interest rate this month to 2.0%. It was the seventh rate hike since 2015 and the second since Jay Powell took over as Chairman of the Fed in February. He signaled two more rate increases in 2018.
Although investors have been expecting the Fed to raise rates, they have been caught somewhat off-guard by the Fed’s earnestness in doing so.
Indeed, some markets have struggled recently on account of a “hawkish” Fed.
- Investment grade bonds have fallen roughly 2% this year as investors anticipate more rate hikes.
- Dividend paying stocks have lagged the broader market as higher interest rates compete for the attention of income-seeking investors. Consumer Staples is the worst performing U.S. sector, down 8%. Indeed, the combination of losses in bonds and conservative dividend paying stocks has made 2018 a challenging year for investors seeking safety and income.
- Overseas stocks and bonds have struggled this quarter as expectations for higher U.S. interest rates have caused the dollar to strengthen and foreign currencies to weaken. Emerging market stocks are down 10% from their January high, though remain up 14% over twelve months.
Investors should view these setbacks as temporary and retain exposure to these asset classes in portfolios.
- Bonds remain important building blocks for conservative investors who value income and capital preservation. Recent losses are neither unusual nor alarming bonds have lost money in 18% of years since 1937. Higher rates also create the potential for better future returns.
- Dividend paying stocks periodically underperform the market, but have outperformed non-dividend paying stocks over the long run. We expect dividend-paying stocks to show improved results if there is renewed uncertainty over the economy.
- Lastly, overseas equities, particularly emerging markets, remain attractively valued, in our view. With U.S. stocks trading at above-average valuations and likely to post below-average returns from todays levels, we believe exposure to foreign markets remains critical for investors to generate solid long-term returns.