This post was meant to be about Simple IRAs, but I chose instead to reflect on the Federal Reserve’s (FED) decision to raise interest rates for the second time this year and how these increases will affect the market.
An interest rate hike has historically been a good thing for an economy because the decision is heavily influenced by the FED’s perception of how strong the economy currently is. The stock market is near a record high and the President-Elect is promising 3% to 4% growth in the coming years. We have not seen growth numbers that high since before the recession in 2008.
Additionally, FED Chairwoman Janet Yellen eluded to the fact that 3 more interest rate increases were possible in 2017, though these were not “carved in stone.” With a raise in rates and a forecast more might be coming in the near future, it seems the economy has a bright year ahead.
An interest rate hike is a strong indicator the outlook of the market is favorable. The investments that will do the best during this period are cyclical industries or consumer discretionary, for example technology and financials. The sectors that should be avoided are ones classified as dividend payers or consumer staples, like utilities and food companies.
Below is a chart that shows the inverse relationship between the two sectors in and around the recession.
Another area to be wary of is the Bond Market. When interest rates go up, bond prices go down. If you are using your bonds for income and waiting to receive the principal back, this should not affect you much. However, if you are using bonds for the interest payments, but plan on selling your bond(s) to a buyer, you most likely will not get a favorable price. Bonds are a good investment for those looking for income, but it is also a good investment for people looking to diversify.
In order to achieve a diversified and effective portfolio, you should allocate your portfolio in different sectors and asset classes. This should help you achieve decent returns during a rally and help protect your investments when the market pulls back.