Climbing the Fed Funds Rates Incline

Peter Girard, Austin Cleveland

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

In September 2023, University of Colorado Boulder alumnus Sepp Kuss won the Vuelta a España (Tour of Spain), one of cycling’s three grand tours and a lesser-known cousin of the Tour de France. Kuss’s specialty lies in riding in the high mountains, a skill he demonstrated during the grueling, three-week 1,960-mile stage race across Spain, as he fought for victory. Some days the race consisted of long flat sections, but things got interesting when the road got steep. Without the steep climbs, Kuss would not have been able to break away from the pack and showcase his strengths.

The macroeconomic environment since the Federal Reserve began their most recent hiking cycle has been like a challenging, high altitude, steep-gradient climb in a cycling race. Higher interest rates put greater pressure on companies to optimize their capital structure and manage debt. Active managers must sort through the wide dispersion of companies who have either successfully navigated the higher rate environment or been crushed by the steep grade of rising rates over the past two years.

federal funds

Correlation of stocks to their index has decreased, meaning that active management’s role in evaluating unique company risk has increased in importance. In periods of highly correlated bull markets, passive strategies or incompetent active managers can hide, similar to a struggling cyclist coasting in the draft of a big group. Additionally, correlation typically rises in periods of crisis valuation drawdowns, such as March 2020. In these periods, active management is highlighted in the portfolio for its downside risk mitigation function.