Opinion: Positioning portfolios for high interest rates in election year

The price level of the S&P 500 began 2024 close to the same level it started in 2022 – but it’s seemingly an opposite set of circumstances.

Instead of starting the year off with 7.5% inflation and on the precipice of higher interest rates to be brought about by the Federal Reserve, inflation was reading at 3.4% going into 2024, and the prospects for lower interest rates are ahead. There’s also the election looming.

Here are some ideas to help you evaluate your portfolio given volatility in the stock market and with interest rates, along with an impact from politics.

Economic backdrop and the markets
From March 2022 through August 2023, the Fed raised the federal funds rate 11 times, ultimately moving the target range from 0-0.25% to 5.25-5.5%. With such a colossal upward move in rates in a short period of time, many leading economists predicted a recession. By the end of 2022, the S&P 500 had shed 19% and the Barclay’s aggregate bond index lost around 13% of its value.

However, the labor market remained strong during the Fed’s nearly two-year bout with inflation. So strong, in fact, that the unemployment rate decreased, moving from 4% in January 2022 to 3.7% in December 2023.

If the labor market remains strong and inflation continues its downward move toward the Fed’s 2% inflation target, the Fed will have successfully orchestrated a soft landing. Given the strong economic backdrop, the stock market appears to be pricing within this possibility.

After posting a 19% loss in 2022, the S&P 500 rebounded 24% to close out 2023. Such wild swings in the stock market make a strong case for developing an asset allocation to match your goals and maintain the discipline to stay the course.

Interest rates and fixed income
For the first time in over a decade, interest rates on fixed income investments have the potential to outpace inflation.

For example, the national average for interest rates on a 60-month certificate of deposit was just 0.75% in April 2021, according to a calculation by the Federal Deposit Insurance Corp. The U.S. Bureau of Labor Statistics reported inflation for 2021 to be 4.7%.

Fast forward to December 2023, and the national average rate calculated by the FDIC for a 60-month CD was 4.3% and inflation was reportedly 3.4%. After decades of losing purchasing power, fixed-income securities are generating income that outpaces the current rate of inflation.

To put this into perspective using the rates calculated by the FDIC, a $500,000, 60-month CD at 0.75% in 2021 would have generated just $3,750 in annual income. At the estimated December rate of 4.3%, that same CD would have generated $21,500 in annual income, according to FDIC calculations.Fixed income instruments can help buoy your overall portfolio in times of heightened volatility and now potentially outpace the rate of inflation. 

Portfolios and politics
Political analysts speculate that the leadership in both chambers of Congress could flip-flop, which would mark the first time ever that congressional chambers change leadership during a presidential election year. Therefore, regardless of who takes the White House, there is a good chance that the U.S. continues with a divided government, paving the way for more gridlock.

It’s important to not let your political leanings drive your investment strategy. Instead, focus on what we know.

We know that we have two years left, 2024-25, before tax rates are scheduled to increase. Barring a Republican trifecta, there is a good possibility that tax rates go up as scheduled.

Therefore, look to maximize tax-advantaged investment accounts now and especially during market drawdowns. Purchasing more shares at discounted prices in tax-favored vehicles could serve you well moving forward. Increasing contributions to employer-sponsored retirement plans, funding traditional individual retirement accounts, Roth IRAs or Roth conversion strategies are all great considerations ahead of the scheduled changes to the tax code.

It’s always good practice to periodically review your portfolio. But especially in the new year, work with your credentialed financial professional to make sure that your portfolio is in tune with current market conditions and that your asset allocation is aligned with your long-term goals.

Andy Drennen is a certified financial planner and senior portfolio manager at Simmons Private Wealth in Springfield. He can be reached at andy.drennen@simmonsbank.com.