All good investors have lost money at some point in the stock market. But only those who learn from mistakes and continue investing succeed. Even billionaire investor Warren Buffett didn’t get it right in the first instance. He earned about 99% of his wealth after his 50th birthday. He invested in the markets of 1942, which saw World War II, the Cold War, the Vietnam War, and the 1980s great inflation when the U.S. Fed interest rate touched its all-time high of 19%.
Sometimes, the market and economy make you see the worst of your investments. But if the company’s business and fundamentals have a future, investing in them in their bad times can give you returns in good times. That’s the best defence in investments.
Understanding the rising interest rate climate
The most pressing issue pulling down the current stock market is the high interest rate. When bank deposits and bond yields generate more than 5% assured returns, the motivation to invest in riskier assets like stocks falls. Investors remove their money from stocks and buy bonds and deposits. That explains the 9.4% drop in the TSX Composite Index since April 2022, when the Bank of Canada started its aggressive rate hike.
However, the interest rate cycle also reaches a peak as higher interest rates are good for depositors but the cause of stress for borrowers. To ease the financial stress of borrowers and encourage spending, the central bank cuts the interest rate. Many economists expect rate cuts in 2024, but the U.S. Fed hinted at only a 25–50 basis points rate cut in 2024.
When the rate cut begins, the flow of investments could likely tilt towards stocks as their returns become attractive. Remember the March 2020 pandemic shock – the central bank reduced the interest rate to 0.25%, encouraging investors to switch to stocks for better returns.
Once you understand the root cause of the market momentum, you can accordingly plan your investment strategy.
Defence stocks to protect your portfolio from interest rate shocks
The investment world sees money changing hands from one asset class to another. It is a zero-sum game in which one’s loss is the other’s profit. In the last two years, you may have lived the former. Now is your time to experience the latter. The fears of aggressive rate hikes saw a tech stock meltdown at the start of 2022 because they were overvalued.
Now, the interest rate has reached its peak. It will most likely fall from here. So, rate-sensitive stocks that fell throughout the rate hike can be a good defence as their valuations have fallen. While high interest rates might pull down their stock price further, the decline will be limited. Using Buffett’s simple investment lesson of buying the dip in interest-rate sensitive stocks could be the way forward.
Two stocks for rate-proof returns
CT REIT stock
Real estate is sensitive to rate hikes as it increases mortgage costs. REITs generally have mortgages on their balance sheet. They also raise debt to fund the development of the property. The aggressive rate hike saw many commercial REITs cut their distribution as their interest rate burden increased.
Unlike other REITs, Canadian Tire’s real estate arm CT REIT (TSX:CRT.UN) has a lower debt of $2.8 billion (86% of its equity) with a weighted average maturity of six years. Its rental income remained unaffected as Canadian Tire leases more than 90% of the REIT’s property. Moreover, its distribution payout ratio is at a comfortable level of 72.5%, whereas many REITs saw this ratio cross 85–90%.
CT REIT stock has slipped 22% since the rate hike began, which elevated its distribution yield to 6.49%. It is among the few REITs that have grown its distribution at an average annual rate of over 3%. The commercial REIT’S fundamentals are strong, making it a stock worth buying at the dip.
Barrick Gold stock
When the stock market falls, gold tends to rise as investors look for low-risk assets. But high interest rates have kept investors attracted to bonds. Gold stocks like Barrick Gold could see a surge once the rate cut begins, as these cuts take time to seep into the economy. Until then, financial stress could pull down the economy and drive gold prices.
