The US Federal Reserve raised interest rates three times in 2017. Cleveland Federal Reserve Bank President Loretta Mester said last Thursday that she believes that the Fed should raise rates three to four times in both 2018 and 2019.
Given that interest rates in the US have a big impact on interest rates in Singapore, it would seem that there’s a high chance that interest rates here could be climbing too. How should we be investing in an environment with rising rates?
One, relook your fixed income holdings. Long-term fixed rate bonds often depreciate in a long-term cycle of rising rates. You may want to consider short-term bond issues, or floating rate bonds whose coupons are based on the current benchmark rate. Unit trusts and ETFs are one easy way of accessing fixed income assets in Singapore. But whether you’re invested in long-term or short-term bonds, keep in mind that even when interest rates rise, bonds have a fixed pay-out – assuming the issuer of the bonds remain solvent – and balances the risk profile of your investment portfolio.
Two, financial companies such as banks, insurers, and brokers tend to do well when rates rise. Rightly so, as their profit margins are largely based on prevailing interest rates. In Singapore, the SOR (swap offer rate) and SIBOR (Singapore Interbank Offered Rate) – both are interbank lending rates – have historically tracked changes in US interest rates pretty closely. In 2017, banking stocks in Singapore generally performed well when compared to the broader stock market.
Three, an increasing interest rate environment signals stronger economic conditions and inflationary pressures. As per the last FOMC (Federal Open Market Committee) statement, US economic growth is expected to be sustained at 2.5% in 2018. Recent data from China also showed that its GDP (gross domestic product) grew 6.9% in 2017, beating the Chinese government’s own forecasts. Under these conditions, cyclical sectors such as energy producers and industrials have tended to perform better than defensive sectors such as healthcare, telecommunications, and consumer staples.
Just because interest rates are rising does not mean we should completely change our investment strategy. Still, investing is not a static and unchanging process. As the global economic picture evolves, it is up to each of us to decide what is the best way of managing risk and yet capture returns.
It is difficult to pick specific winners, but it is relatively easier to make educated guesses on what sectors and asset classes will do well in the coming three to five years based on current economic conditions and historical correlations. Investors can participate in these broad trends through unit trusts and/or ETFs (remember to keep your costs low if you’re looking at unit trusts!).
Worried about the overall state of the market? Do you know the 1 thing you should never do in the stock market? The Motley Fool Singapore's new e-book lays out a plan to handle market crashes, details the greatest advantage you have as an investor, and looks at decades worth of market data to bring you the smartest insights on investing. You can download the full e-book FREE of charge--Simply click here now to claim your copy.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.