It seems like just a few months ago that we were preparing our investments for a lengthy ride of increasing interest rates and an uncertain market. Fast forward to now and the talk is all about Fed rate cuts and if the market can continue to hit new highs in 2024. The question isn’t really whether the Fed will cut rates, but how many times and by what amount. The futures markets have a crystal ball and tell us of a one hundred percent certainty of a rate cut by June of 2024, with some saying there may be as many as six rate cuts to come.
Perhaps the biggest beneficiaries of the rate increase over the last several years have been savings accounts and certificates of deposit. These time deposits are tied to the benchmark short term federal funds rate, which last spring was close to zero. As such, banks offered you little to nothing in the way of interest on your accounts. That’s all changed. By July 2023, the Fed’s “target rate” had risen to between 5.25% and 5.5%, its highest level in more than two decades, with banks gradually raising the rates they paid out on these time deposits. According to Phil Blancato, chief market strategist for wealth management company Osaic, “Right now, more than likely, is the peak of interest rates.” The following image gives you an idea where savings products and CD’s are currently.
Let’s take a look at CD’s first. Some one year rates are hitting 6% currently, but can be expected to fall along with any Fed rate cuts. Rates generally fall with maturities, so to get something in the five year range might yield around 5.3%. One solution then, is to commit some cash to a one year CD. Always remember to only commit cash that you won’t need for the duration of the lockup. Penalties for early withdrawal will negate any interest you’d be receiving. According to Gail Reid, a financial advisor in Glendale, Calif, “If people lock up too much and then the car dies, or they have to repair the roof, they won’t have the cash ready.”
Savings accounts come with the flexibility of removing your money at any time, but also come with the risk that banks will almost certainly lower rates in tandem with the Fed. According to Adam Stockton, head of retail deposits at research firm Curinos, “Just as rates increased unevenly across different banks, some banks will decrease rates faster than others.” Flexibility vs yield is typically what it comes down to when deciding which time deposit to place cash in. One way to kind of get the best of both worlds is with a CD ladder. Similar to a bond ladder, or any other fixed interest asset, you divide your cash among accounts with varying maturities, like three month, six month, nine month, etc. This way you can lock in higher rates and still have cash maturing every three months in this example.
If you’re so inclined, there are several ways to play the equities markets in anticipation of lower rates. Historically, several categories have done well in this environment. According to data from Goldman Sachs, the top performing sectors were health care and consumer staples. Health care has outpaced the S&P 500 by a huge margin, a median of 9 percentage points, over the 12 months following the start of a rate-cutting cycle. However, tech stocks were the worst performing sector, lagging by 13 percentage points over one year. Could be time to take some profits off the table in the “magnificent seven” and other technology issues that have been up some 40% this year.
Several themes also tend to play out during times of rate-reversals and Fed pivots. One popular hedge fund theme is what is known as long/short momentum factor. The premise to this theory is quite basic. The strategy is based on a simple idea, the theory about momentum states that stocks which have performed well in the past would continue to perform well. On the other hand, stocks which have performed poorly in the past would continue to perform badly. This results in a profitable but straightforward strategy of buying past winners and selling past losers. The Goldman study showed that the long/short factor returned a median of 9% during the year following prior rate cuts.
The risk-return trade off during the period of higher yields makes equities less attractive, all other things being equal. However, a steady pace of inflation, as in the Fed’s 2% target, can help capital assets grow, increasing the benefits of having a healthy allocation of stocks in your portfolio. Equities also give one the advantage of having a longer term investment horizon, allowing you to ride out the highs and lows of inflation.
Remember that there are two components to the financial statement, income and expenses. Understanding the expense side is just as important in inflationary times. Even though inflation is declining, prices are still increasing, just at a more gradual pace. This means there is still less for you. Adjusting your spending habits will help. According to Walmart chief financial officer John David Rainey, “Consumers are leaning heavily into major promotions as they watch their spending and search for deals. “ Less can be more in times of financial tightening, albeit difficult for many. If budget tightening doesn’t cut it, more draconian measures might need to be considered. Perhaps the hardest, but most impactful, is downsizing your home, or moving to a more affordable area. If doable, this will help your finances enormously, and give you the most peace of mind.
