So, the Federal Reserve has decided to cut interest rates by half a percent or 50 basis points to 5% last month. It was a lot more aggressive than most people were expecting. That should have delighted the market. After all, a bigger-than-expected weight has been lifted off stock markets around the world. An even bigger weight has been removed from emerging-markets currencies.
But guess what? Some quarters of the market are far from elated. Sceptics think that the Fed had been forced to make a bigger cut in the Fed fund rate because the American economy could be heading into recession. You just can’t make this stuff up. The Fed can’t win whatever it had decided to do.
But here’s the thing: what the Fed does or does not do shouldn’t matter a jot to investors with well-balanced portfolios. A portfolio that is properly constructed should be able to cope with every economic conditions that include high interest rates, low interest rates, rapid economic growth, recession or even unfortunate geopolitical events.
Consider banks. High interest rates are generally good for lenders because they can make supersized profits quite effortlessly. It could be a lucrative time to own bank shares. But when interest rates are heading lower, banks have to work harder to make up for a narrower net interest margin by extending more loans.
Now consider Real Estate Investment Trusts or REITs. Unlike banks, they prefer lower interest rates because they make use of loans to amplify their profits. When interest rates are high, more of their rental revenue could be used to make higher interest payments. But when interest rates are low, more rental revenue could flow into the pockets of unit holders through generous distributions.
So, here’s the thing. Should we be continually jumping back and forth from banks to REITs every time there is a likely change in interest rates? We could. But what a dreadful waste of time and energy, not to mention the fees and commissions we will have to fork out when we do so.
A well-balanced portfolio that include both banks and REITs could mean that any weakness in the banks could be compensated by strength in the REITs, and vice versa. Additionally, the portfolio could continue to generate reliable income that can be used to buy more shares in weakened sectors, if we want.
Point is, economic cycles and the ensuing interest rate movements are part and parcel of investing. They should be seen as opportunities rather than threats. And the best way to tame the interest-rate beast is to have a robust portfolio. Otherwise, we end up getting pushed from pillar to post that doesn’t benefit anyone apart from brokers.
So, the question is this: will the next interest-rate decision be up, down or, perhaps, no change? Well, if we have a properly balanced portfolio, then it doesn’t really matter.
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Disclosure: David Kuo does not own any of the shares mentioned.
