Rising government bond yields are disrupting investors’ portfolios, a trend they will have to learn to live with, according to Gargi Pal Chaudhuri, chief investment and portfolio strategist at BlackRock’s Americas division, which manages $4.7 trillion in assets.
“We believe we should all get used to a world where interest rates stay higher for longer,” Pal Chaudhuri told Themoneytimes on Monday.
In BlackRock’s Fall Investment Directions report, published on Tuesday, she outlined several key factors that could continue pushing yields upward, including:
– AI companies’ insatiable demand for capital as they borrow to fund their AI infrastructure spending. Corporate bond issuance rose 27% year-over-year in July.
– Increased Treasury issuance as US government expenses grow. A growing supply of Treasurys in the market tends to push yields up.
– Strong economic growth, with Q3 GDP expectations elevated.
– Uncertainty around fiscal policy. It’s unclear if spending will continue on its current path as government debt has reached a record high of $40 trillion.
– Federal Reserve credibility. New Fed chair Kevin Warsh has spoken tough on inflation, but has yet to raise interest rates.
Other factors that have lifted bond yields in recent days include the Treasury’s announcement that it would expand its bond buyback program to help suppress long-end yields; rising oil prices due to the US-Iran war; and rising Japanese bond yields as investors fear the country could strengthen its currency.
The Bloomberg Global Aggregate Treasury Index hit its highest level since 2008 on Tuesday.
The upward move in yields has roiled stocks. As of early afternoon on Tuesday, the S&P 500 was down 0.73%, while the Nasdaq 100 fell 1.3%.
To prepare your portfolio for the new era of higher long-term interest rates, Pal Chaudhuri shared a few steps investors can take.
3 ways to prep for higher yields
First, move down the yield curve to short- and intermediate-duration bonds.
This reduces exposure to any further upside in long-end bond yields, which could bring your portfolio’s value down. Medium-duration yields also give investors some solid income — for example, 5-year Treasury yields sit at 4.54%.
Second, she said to add exposure to dividend stocks, which are typically less volatile than the broader market and offset losses with payouts to investors.
Dividend stocks can also help offset inflation, as companies issuing them often have the ability to raise prices, which is reflected in rising dividends.
Pal Chaudhuri said she is seeing clients add to this area of the market right now.
Finally, Pal Chaudhuri said to look at quality stocks, defined as companies with stable earnings growth, high free cash flow, strong balance sheets, and a durable competitive advantage.
She said that high free cash flows, in particular, are important, as investors are increasingly concerned about AI spending levels, with some firms dumping all of their excess cash into the AI infrastructure buildout.
With higher yields not ideal for multiple expansion in stocks, earnings are increasingly important, as they are what are driving share price growth now. So, companies with consistent earnings growth and strong balance sheets are arguably best positioned for upside.
Pal Chaudhuri oversees multiple funds at iShares that touch on these themes, like the iShares MSCI USA Quality Factor ETF (QUAL), the iShares Select Dividend ETF (DVY), and the iShares 1-3 Year Treasury Bond ETF (SHY).
Other funds that offer exposure to these themes include the Invesco S&P 500 Quality ETF (SPHQ), the Vanguard High Dividend Yield ETF (VYM), and the Schwab Intermediate-Term U.S. Treasury ETF (SCHR).