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Investment strategies to grapple with high inflation, rising interest rates


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Prices are soaring. And it’s not the good kind of price gains (a.k.a. rising share prices).

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Hey there, time traveller!
This article was published 23/04/2022 (227 days ago), so information in it may no longer be current.

Prices are soaring. And it’s not the good kind of price gains (a.k.a. rising share prices).

Inflation is reaching levels not seen since the early 1990s.

In turn interest rates are likely moving upward in a way not seen in years, either.

So what does this all mean for stock prices, and for that matter income investments like bonds and GICs?

“Overall, inflation and rising rates at the same time are like a tax on wealth,” says Paul de Sousa, investment adviser with Sightline Wealth Management in Toronto.

You pay more for goods and services, while potentially paying more on your debts.

“So it’s a double-whammy,” he adds.

With this in mind, the first order of business is to start paying down debt, faster. This applies most to lines of credit and variable-rate mortgages, which move up and down with the prime lending rate — now 3.2 per cent, up from 2.45 per cent at the start of the year.

From an investment perspective, paying down the line of credit these days is like a guaranteed 3.2 per cent return on your money. That’s better than yields on bonds and rates in GICs right now.

As for actual investments, however, those involved in holding or producing hard assets often do well in times like these, says Doug Nelson, portfolio manager with Nelson Portfolio Management Corp. in Winnipeg.

Think energy, materials, real estate and gold. Because purchasing these assets cost more due to inflation, producers or owners of these assets also tend to earn more.

“Banks can also do well,” Nelson adds.

The reason being the spread between the interest rate at which they borrow money and the higher interest rate at which they can lend it out often grows wider.

So they earn more profit.

Insurance companies also often make out well because eventually they invest in bonds bearing higher interest rates resulting in more stable returns to meet liabilities — paying out life policies, for instance.

Even investment brokerages tend to do better because they too lend money for margin accounts with better spreads.

One challenge for stocks is that despite the economy performing well — itself, a cause of higher prices — higher interest rates often take time to ease inflation.

In the meantime, consumers may consume less.

As such, playing portfolio defence is recommended, says Paul MacDonald, chief investment officer with Harvest Portfolios, a Canadian provider of exchange-traded funds (ETFs).

“You still want to be invested in the equity side of the portfolio but focusing more on good, quality stocks.”

These are firms with strong balance sheets (not carrying a lot of debt ) and good transparency on how they earn their money. Essentially, the longer their history of producing profits is, no matter the conditions, the more likely these companies will continue to be profitable in future.

MacDonald adds consumer staple companies like Johnson & Johnson are considered defensive.

That’s because consumers need what they sell, higher prices aside.

In contrast, companies involved in discretionary spending — alcohol, automobiles, travel, sports and hobbies — may not fare as well because consumers have less disposable income, due to rising prices and higher debt payments, to purchase non-essential items.

Technology-related stocks may not grow as much as in recent years as many may fall under the discretionary banner.

Yet it’s still worth owning big tech like Apple, Cisco and Amazon (which is a leading cloud services provider).

The fact is technology is just too important.

“Technology plays a significant role in helping companies been more efficient,” Nelson explains. “Therefore, reasonably valued technology companies, with growing cash flow and earnings, can also be a reasonable investment consideration during times like these.”

Overall diversification remains important because no one knows with certainty what will happen next year or a decade from now.

Of course, it is very likely bonds will struggle as long as interest rates rise.

So you’re likely to see the bonds in your portfolio lose their value as rates climb for the next year and a half or more. These investments are still likely to pay their coupon (interest) central bank rate, hikes aside.

For more conservative investors needing income, bonds remain a necessity because they provide that stable, baseline income.

Still these investors may want to consider alternative strategies — like private debt funds — that are not as affected by rising rates, Nelson says.

As well, these investors can look to supplement income from bonds with dividends from stocks and distributions from real estate investment trusts (REITs). Again, quality companies with a long history of paying shareholders is preferred.

And there is light at the end of the tunnel for income investors. Rising interest rates will eventually lead to higher payments from bonds and GICs, de Sousa says.

In the meantime, a re-evaluation of investing, debt repayment, spending and saving is in order, he adds.

“In particular, those close to retirement or retired face the most risks, and so it’s really worth their while to revisit those retirement projections sooner than later.”

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