Nov 7, 2015

How to Invest in a Rising Interest Rate Environment

In the last economic update whereby I provide the rationale for the aggressive allocation into Europe, I have essentially summed up some of the most important economic events for the month of October. The  release of a stronger than expected US Job report on 6th of Nov had analysts scrambling to pronounce that there is a possibility of an interest rates rise again.... up from a near zero probability a week ago, before the end of 2015. I just wish that these analysts will just make up their minds and stop scrambling around like confused hamsters while trying to look smart at the same time.

In any case, a rising interest rate environment is not neccessarily a bad thing.

In an interview with Robert R. Johnson, the author of Invest with the Fed, Johnson sums up the impact of interest rates on the US stock market in one paragraph:

"Over a 48-year period from 1966 through 2013, the S&P 500 (SPY) returned 15.18% during expansive periods  and only 5.89% during restrictive periods.  The Fed was expansive and restrictive about the same amount of time.  One of the most interesting findings of our research is that stock market returns are not as correlated with the level of interest rates (whether rates are high or low) as they are with the direction of interest rates (whether rates are trending up or down)."

His findings is similar to my hypothesis, based on a personal research that I have done compiling historical interest rates and stock returns data. In fact, during 2005-2007, when the US interest rates was on the rise, the US stock market performed positively, thanks to the halo effect of the perception of an improving economy with many investors still willing to put money in the stock market in spite of a more attractive saving rate. However, what happens after the rise of interest rates often ends in an economic shock or recession. That is another story best reserved for another day.

On the topic of equity investment out of US, Johnson has this to say: 

"The good news for investors is that emerging markets (EEM) and frontier markets (FM) have exhibited a very different pattern with respect to Fed monetary policy.  Emerging and frontier markets have performed much better when the Fed has been restrictive than expansive.  I would caution that this evidence is based on a much shorter sample period than the nearly half-century period for the traditional asset classes."

I tend to disagree with this statement as the economic status quo has changed some what with the rise of China and her economic might. Many a times, interest rate was being raised in respond to an expanding economic situation in US which translate to a rise in demand for goods and services which are manufactured in emerging markets for the past 60 years. The emerging economies benefited and their stock market rose as a result. However, in the past 20 years, the dependence on the US economy has wane and the main driver of the emerging market economies, especially for East Asia, has been China. For example, China is currently the largest trade export partner for Singapore which has over taken Malaysia and US in the past decade.The expansion of the US economy will no doubt benefit Singapore, but a contraction of the Chinese economy will have a bigger impact on our economy, greatly offset any benefits that we gain from US. The Singapore trade story is similar to many economies in Asia and I will not still not place my bets on Asia, contrary to the research done by Johnson.

My strategy is to still consistently maintain the majority of the portfolio into the US and Europe market and maintain a token allocation into the Asian markets as what I have done in the past 3 years.

Portfolio Performance

Our switch into equities during the worst of the September correction has yield returns at last and the portfolio gained 2.13% for cash and 3.22% for OA/SRS for the month of October. The non-cash portfolio did better due to a sharp fall in USD as a result in a surprised positive performance by the Singapore economy, leading to a strengthening of the SGD. However, I expect the sharp rise in SGD to be temporary as the MAS pursue of gradually weakening the SGD for export competitiveness and the rise in US interest rates will no doubt improve the performance of the USD cash portion of the Cash portfolio. We are unable to capture the full performance of the equity market during the rally period in October but I was cautious in allocating the full amount into the equity market for the fear of a false rally. In any case, we are on track for a year with superior performance in a difficult year where most of the Asian and Emerging Market stock indices are still mired in red. The portfolio was able preserve the capital and maintain low volatility by not falling more than 1% in a single month during 2015 thanks to this cautious approach and I intend to keep it that way.  


  1. Hi,

    Any thoughts on the Australian stock market w.r.t Fed policy?

    1. Hi, are you a Singapore or an Australian?


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