After a challenging 2022, stocks have gotten off to a good start in 2023. The S&P 500 index is up 7.7% through Feb. 14 and the Nasdaq is up 14.3%.
With inflation starting to come down and the economy remaining stable, investors are starting to sense that they may get the soft landing they had hoped for, meaning the Federal Reserve can bring down inflation to its target rate of 2% without sinking the economy.
However, the Fed has promised to stay the course keeping interest rates elevated until inflation is back under control, and Fed Jerome Powell indicated that rates were likely to move higher following the 25-basis-point hike on Feb. 1.
The recently released January Consumer Price Index (CPI) data also shows that inflation may be more stubborn than some had hoped. Year over year, the CPI was up 6.4%, a slight decline from 6.5% in December. Yet food inflation remains high, and on a monthly basis, the CPI rose 0.5%, its fastest pace since October when it also rose 0.5%.
It makes sense that investors would be focused on interest rates. After all, rising rates dominated the stock market narrative last year, and the Fed has the potential to take center stage again, but there's nothing you can do about rising interest rates. Instead, you're better off focusing on the things you can control.
Image source: Getty Images.
Revisit your investing goals
How you invest in a high-interest rate environment will depend on your investing goals and your time horizon.
If you're investing money you won't need for several years, higher rates could offer a good opportunity to buy growth stocks that are on sale. Roku (ROKU -10.29%), for example, was down more than 80% from its peak in 2021, largely because higher rates have crushed advertising demand as brands anticipate a recession. Still, Roku remains the leading streaming distribution platform, and its latest financial report shows that the company appears to have a bright future, especially once the economy starts to bounce back and advertising demand returns.
Conversely, if you're a retiree and have a short time horizon, you may be looking for a way to capitalize on rising interest rates now. One way to do so is by investing in mortgage REITs, which tend to benefit from a rising-interest rate environment as mortgage REITs aim to borrow at a lower interest rate and then hold mortgage debt that pays at a higher interest rate. With mortgage rates now elevated, that should be easier to do. One example is AGNC Investment (AGNC 0.97%), a residential mortgage REIT, which currently pays a 12.6% dividend yield and pays its dividend on a monthly basis.
The best of both worlds
Some stocks offer growth potential, but also a way to benefit from higher interest rates because they collect interest on the funds they hold for customers.
Airbnb (ABNB 0.75%), which just reported fourth-quarter earnings, collected $103 million in interest income on the nearly $5 billion in funds it held for customers, as the company can earn interest on the money it holds in between customer bookings and stays.
Similarly, Bill.com (BILL 3.21%), a software company that helps small and medium-sized businesses, also earns interest on funds it holds for customers. In its most recent quarter, the revenue it earns from interest, which it calls float revenue, made up 11% of its total revenue, or $28.9 million, in the most recent quarter.
Airbnb and Bill.com can help growth investors hedge their bets on interest rates, since these stocks will get a boost on the bottom line as long as interest rates remain elevated.
It's impossible to know what will happen with interest rates or inflation over the course of 2023 and beyond. If you're an investor, the best thing you can do is assess your needs and prepare your portfolio to succeed in any environment. That means considering your time horizon, diversifying your portfolio, and owning stocks like the ones above that offer a range of ways to win from rising interest rates.
