If you were hoping for a return to low interest rates and a bond rally in 2024, you may want to hold the champagne: Inflation doesn’t appear to be going away anytime soon.
After pricing in almost seven quarter-point Federal Reserve rate reductions earlier this year, futures traders are lacking confidence in a single rate cut. Meanwhile, 5-year Treasury bond yields passed 4.5% on their way toward last year’s highs of nearly 5%.
Rising interest rates are also putting pressure on top-heavy equity markets. Real GDP growth clocked in at just 1.3% during the first quarter of 2024, reflecting a slowdown in consumer spending amid higher interest rates.
If inflation continues to rise while economic growth slows, investors could experience a fate worse than a recession – stagflation.
Let’s look at how to protect your portfolio.
Where To Invest?
Falling bond prices and a top-heavy equity market may seem to put all investments at a disadvantage, but there are some sectors that outperform in these conditions.
Commodities
The most obvious example is commodities.
During the 1970s, commodity prices soared as other assets experienced a sharp decline. Most notably, gold prices rose from $300 in 1970 to nearly $2,000 per ounce by the end of the decade – a spectacular 566% return while the S&P 500 rose by just 89%.
Popular Commodities ETFs
These ETFs are sorted by their YTD total return, which ranges from 5.6% to 9.4%. They have AUM between $930M and $4.7B and expenses between 0.32% and 1.02%. They are currently yielding between 0% and 4.7%.
| Name | Ticker | Type | Active? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| iShares S&P GSCI Commodity-Indexed Trust | GSG | ETF | No | $933M | 9.4% | 0% | 0.75% |
| First Trust Global Tactical Commodity Strategy Fund | FTGC | ETF | Yes | $2.4B | 8.1% | 2.7% | 1.02% |
| abrdn Bloomberg All Commodity Strategy K-1 Free ETF | BCI | ETF | Yes | $948M | 6.9% | 3.7% | 0.32% |
| Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF | PDBC | ETF | Yes | $4.76B | 5.6% | 4% | 0.67% |
| Invesco DB Commodity Index Tracking Fund | DBC | ETF | No | $1.69B | 5.6% | 4.7% | 0.85% |
Value Stocks
Value stocks are another asset class that does well in recessions.
During the 1970s, the most expensive stocks delivered a 25.8% return, whereas the cheapest rose 213%. The most likely explanation is that cheap stocks have less room to fall during a bear market and more room to rise during a recovery.
Popular Value ETFs
These ETFs are sorted by their YTD total return, which ranges from 4% to 8.5%. They have AUM between $10B and $163B and expenses between 0.04% and 0.34%. They are currently yielding between 1.2% and 3.4%.
| Name | Ticker | Type | Active? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| Vanguard Value Index Fund | VTV | ETF | No | $163B | 8.5% | 2.5% | 0.04% |
| iShares MSCI EAFE Value ETF | EFV | ETF | No | $17.1B | 8% | 3.4% | 0.34% |
| iShares Russell Mid-Cap Value ETF | IWS | ETF | No | $13.6B | 6.3% | 1.2% | 0.23% |
| Vanguard Small-Cap Value Index Fund | VBR | ETF | No | $52.9B | 4.9% | 2% | 0.07% |
| Avantis U.S. Small Cap Value ETF | AVUV | ETF | Yes | $10.9B | 4% | 1.3% | 0.25% |
Real Estate
You might be surprised to see real estate stocks on the list.
Higher interest rates are causing headaches for the commercial real estate space, which was already suffering from rising office vacancies. However, REITs with strong balance sheets and exposure to residential tenants can often pass on rising costs.
Popular REIT ETFs
These ETFs are sorted by their YTD total return, which ranges from -5% to -3%. They have AUM between $2.3B and $64B and expenses between 0.07% and 0.40%. They are currently yielding between 1.6% and 3.5%.
| Name | Ticker | Type | Active? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| iShares Core U.S. REIT ETF | USRT | ETF | No | $2.34B | -3% | 2.1% | 0.08% |
| Schwab U.S. REIT ETF | SCHH | ETF | No | $6.36B | -4.3% | 2.2% | 0.07% |
| The Real Estate Select Sector SPDR Fund | XLRE | ETF | No | $5.92B | -4.4% | 2.8% | 0.09% |
| iShares U.S. Real Estate ETF | IYR | ETF | No | $3.47B | -4.8% | 1.6% | 0.4% |
| Vanguard Real Estate Index Fund | VNQ | ETF | No | $63.6B | -5% | 3.5% | 0.13% |
Foreign Stocks
Foreign stocks round out the list.
The U.S. dollar is relatively strong today, but if inflation continues, it could weaken against other currencies. If you purchase a foreign company earning foreign currency that’s appreciating against the dollar, you’re effectively earning an extra return.
Popular Foreign Stock ETFs
These ETFs are sorted by their YTD total return, which ranges from 6.5% to 7.7%. They have AUM between $19B and $184B and expenses between 0.03% and 0.33%. They are currently yielding between 1.9% and 3.6%.
| Name | Ticker | Type | Active? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| iShares MSCI EAFE ETF | EFA | ETF | No | $53.4B | 7.7% | 2.3% | 0.33% |
| iShares Core MSCI EAFE ETF | IEFA | ETF | No | $109B | 7.2% | 2.6% | 0.07% |
| SPDR® Portfolio Developed World ex-US ETF | SPDW | ETF | No | $19.2B | 6.7% | 1.9% | 0.03% |
| Schwab International Equity ETF | SCHF | ETF | No | $35.4B | 6.6% | 3.6% | 0.06% |
| Vanguard Developed Markets Index Fund | VEA | ETF | No | $184B | 6.5% | 2.3% | 0.06% |
Active vs. Passive ETFs
Changing market conditions open the door for active managers to outperform. Rather than investing in today’s largest companies, like index funds, active managers can assess how changing markets might influence different sectors.
For example, investing in the largest foreign companies doesn’t maximize the benefit of a weaker dollar. Instead, active managers might seek out equities in countries that could see the greatest gains against the dollar, potentially boosting returns.
Similarly, not all commodities should be treated equally. Oil prices depend heavily on demand that may dry up during a recession, sending prices lower despite rising inflation. On the other hand, investors may shift from gold to cryptocurrencies as a hedge.
Of course, you should be aware of performance and cost when looking for the best options for your portfolio. Active ETFs typically have higher expense ratios than their passive counterparts, while many fail to consistently beat their benchmarks.
The Bottom Line
Rising inflation, higher interest rates, and slowing economic growth could create turmoil for the financial markets over the coming year – particularly with equity valuations near their all-time highs. Fortunately, there are several sectors that could outperform during a recession or worse, a stagflation environment.
