What Outperforms When Rates Rise?

Tim Strauts: Today, we're going to examine how different asset classes perform in different interest-rate environments. The chart looks at the time period from February 1972 to April 2015 and divides each month into one of three different periods.

In an expansive period, the Federal Reserve has followed an easy-money policy that is defined by a decreasing discount rate and a decreasing Federal funds rate. In a restrictive period, the Fed has followed a tight money policy that is defined by an increasing discount rate and an increasing Federal funds rate. Finally, in an indeterminate period, the Federal Reserve's intentions are uncertain because one measure is rising and the other measure is falling.

Overall, the asset classes shown have similar returns over the full period, but diverge quite dramatically depending on the interest-rate environment. Stocks tend to perform best in an expansive period and worst in a restrictive one.

On the other hand, commodities and gold perform best in a restrictive period and worst during an expansive period. Commodities have underperformed for the last three years, but we may be moving into a period of rising interest rates. If that happens, commodities may break out of their performance slump and start outperforming other asset classes again. Since we don't know when the Federal Reserve will make policy changes, it isn't a good idea to try to time Fed policy. But since a restrictive monetary policy is likely sometime in the next few months to few years, it may make sense to have an allocation to real assets like commodities, which help provide inflation protection.