The good news is that I expect that interest rates, and mortgage rates by proxy, will continue to increase at only a modest pace. The Fed knows that the recovery is still tepid, and higher rates will slow it further. In addition, the majority of a near-term adjustment in rates ahead of a likely fall taper has already taken place.
But there is the risk of rates rising faster than I expect. If frustrated investors start to aggressively sell bonds, long-term rates could go too high too fast, endangering the housing market and the recovery.
In this environment, I continue to advocate that investors should:
- Expect more volatility.
- Consider overweighting stocks relative to bonds. While stocks and bonds are likely to remain volatile in the near term, assuming inflation stays muted and the rate rise is gradual, I believe that stocks will likely do a better job of withstanding rising rates than bonds.
- Remain cautious of segments of the equity market vulnerable to rising rates, including utilities stocks and consumer discretionary companies, especially those tied to the housing market, such as home builders.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.