Take Interest in the Fed's Recent Hike

Physician's Money Digest, October15 2004, Volume 11, Issue 19

What goes up must come down. Conversely,particularly where interest ratesare concerned, what goes down mustcome back up. And on Sept. 21, theFederal Reserve raised interest rates by a quarter percentagepoint to 1.75%. This is the third hike by the fedthis year. Let's take a look at how rising interest ratesaffect the investment world.

Stocks Like Hikes

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You might be surprised to learn that stocks historicallydo well after an initial rate hike. According tomagazine, since 1928, when the fed first raisedinterest rates, stocks have increased more than they didprior to that year. In the year following initial hikes, theS&P 500 rose 9% on average vs 7% in other years.History also indicates that growth stocks have performedwell in the early stages of a period of rising rates.

According to Ned Davis Research (www.ndr.com),when the yield on the 30-year US Treasury bond rises10%, the best-performing stocks come from growthindustries such as technology (up 20.4%) and energy(up 14%). In contrast, banking (down 2.8%) and utilities(down 13.3%) have historically been the worst-performingindustry sectors.

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magazine also suggests investors considerthe pharmaceutical sector, a growth industry that hastraditionally had demographic trends on its side and aminimal relationship to interest rates. Battered downby pricing pressures and regulation concerns, manydrug stocks are currently bargain priced, but couldhave growth spurts in the future.

Bonds Beat Treasuries

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The article notes that during the past fourperiods of rising interest rates, short-term bonds havedramatically outperformed long-term US Treasuries.During the most recent period (ie, October 1998through January 2000), long-term Treasuries fell 6.3%while short-term bonds rose 3%. What that means forinvestors depends on their time horizons.

If you have retirement savings in an intermediatebond fund but don't plan on retiring in the near future,you can certainly ride out any volatility the bond marketmight experience. However, if you will need to draw onthose savings soon, consider moving them to a moneymarket fund or a short-term bond fund that has an averagematurity of 3 years or less.

A good alternative to long-term Treasuries isTreasury Inflation-Protected Securities (TIPS). Thesesecurities have payouts that keep pace with inflation,and they can be acquired directly from the governmentat www.treasurydirect.gov or through TIPS funds fromcompanies like Vanguard (www.vanguard.com) andFidelity (www.fidelity.com).

Consider Your Options

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Many investment experts are turning to otherinvestments (eg, real estate stocks and commodities) asways to broaden the type of assets in which theyinvest. According to the article, the reasonthey're doing this is because "the ballooning budgetdeficit will lead to lower investment returns fromstocks and bonds in the coming years."

Broadening the type of assets in which you investcould help you gain some extra performance. Andbecause alternative investments like real estate and commoditiesdon't move in sync with stocks and bonds, theyprovide further portfolio diversification.

The article suggests that newcomers to real estatemight want to start dollar-cost averaging into a top-rated,no-load fund such as the Third Avenue Real EstateValue fund (www.thirdavenuefunds.com), which investsin developers. For those already investing in real estate,make certain that gains haven't pushed your allocationbeyond 10% of assets.

On the commodities front, because prices have risenconsiderably as of late, start slowly by dollar-cost averagingand committing no more than 5% of your assets.Consider a diversified commodity fund like the T. RowePrice New Era fund.