A hike in longer-term government bond yields has been the primary cause of market volatility that we have been expecting for some time, observes Brian Kelly, fund expert and editor of MoneyLetter.

The rise in interest rates, mainly in response to perceived threat of higher inflation, has kept the predominantly good economic news in check. Manufacturing has improved to a three-year high and coronavirus vaccines are slowly changing the pandemic outlook.

We see recent interest rate moves as a type of "reset" as the economy recovers, and not a runaway trend. You can take heart in the fact that stock prices have a history of advancing during periods like this.

And our bond market positions, while not completely immune from rate increases, are thoughtfully selected to ride out a period of moderately rising interest rates. Our model portfolios are invested in bond fund positions that are best designed to weather a modest increase in market rates.

Our short term, floating rate and multi-sector bond bond funds are more flexible than core bond funds. While their NAV can still be affected by rising rates, their investment strategies help to minimize price declines and tend to adjust as rates settle.

Indeed, last week we recommended a trade: all conservative inves­tors were told to sell 10% from our growth & income or “hybrid” positions and invest the proceeds in floating rate bond funds.

In our Conservative model, the new fund is Eaton Vance Floating Rate Bond Fund A (EVBLX). In the Fidelity Conservative portfolio, the new buy is Fidelity Floating Rate High Income (FFRHX).

Vanguard does not offer a float­ing rate fund, so the replacement for Vanguard investors was Vanguard GNMA Investor (VFIIX).

One caveat is that floating rate funds typically invest in lower-rated debt securities when compared to US Government or core bond funds. These bonds can be more volatile and have greater default risk during uncertain financial conditions.

Investors had been concerned about the recent move higher in long-term interest rates. But according to Fed Chief Jerome Powell, these increases are transitory and not the beginning of a structural shift.

The Federal Reserve announced that it does not expect any interest rate hikes through 2023. The plan to keep short-term rates near zero comes amid projections of stronger economic growth and higher inflation in the months ahead.

The Fed seems prepared to live with higher year-over-year inflation readings over the next several months, which Chairman Jerome Powell sees as transitory due to the effects of the pandemic.  
For domestic stock funds, there are three new Buys: Vanguard Small Cap Value ETF (VBR); Vanguard Small Cap Value Index Investor (VISVX), which is closed to new investors; and T. Rowe Price Small Cap Value (PRSVX).

For International Stock Funds, there are five new Buys: Oakmark Global Investor (OAKGX), Oakmark International Investor (OAKIX), Dodge & Cox Global Stock (DODWX), Oakmark International SmallCap Investor (OAKEX), and Oakmark Global Select Investor (OAKWX).

Overall, we are in the middle of a market-friendly period, where the economy is not too hot and not too cold. Enjoy the gains.

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