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29 April 2024
In case you haven't noticed, the stock market has been bumpy for the past couple of weeks, with the S&P 500 index recently down about 2% from its April 11 level. Investors are in a pessimistic mood and it's largely because the deep interest-rate cuts that the market expected early in the year just aren't materializing.
If interest rates stay high, there will still be opportunities to make money in the stock market—but investors would need to evaluate their holdings and potentially make some changes.
Here's how we got here. The Federal Reserve started raising rates in in March of 2022 as it became clear that high inflation was a problem that wasn't going to solve itself. By July of 2023 short-term interest rates had gone from close to 0% to over 5%. But while inflation has slowed, it rate of consumer price increases remains at 3.5%, higher than the Fed's 2% inflation target.
Now the market's interest-rate expectations have changed: Instead of the six quarter-point rate cuts this year, the consensus is three or even less. My opinion is that there's a 60% chance we don't see any rate cuts from the Fed this year.
If that's the way things play out, here are a few things to watch for. First, I think the housing market would continue to be in a funk. The average interest rate on a 30-year mortgage is 7.5%, the highest level in two decades. That's hitting demand for buyers of existing and new homes, which is weighing on companies that provide housing materials. When interest rates are high, that's generally a sector of the market to avoid, and it's part of why the economy in general could struggle in the next few months.
Another sector that is likely to be hit hard by a higher-for-longer environment is small-cap stocks. Smaller companies need to borrow capital to grow, and higher costs of capital push their profitability lower. Meanwhile, elevated inflation usually hits consumer-discretionary industries. Americans could rein in their vacation travel, for instance, hurting companies in related businesses.
Meanwhile, I'd be very careful and selective with corporate bonds in a high-rate environment. There are a lot of debt-laden companies out there, and with higher rates, the risk of default is greater than I think the market appreciates.
Where would opportunities be found in a continuing high-rate environment? A good place to look is companies that have low levels of debt, that are increasing their sales and that have the cash to purchase distressed companies. Some of the biggest and best-know technology companies have billions of dollars of cash available, and as small companies wrestle with high-interest debt, they can virtually pick and choose the ones they want to acquire.
As always, choosing the right mix of investments depends on your goals, your timeline and your comfort level with risk. Don't hesitate to get in touch with us if you'd like to discuss your investment portfolio.