The Federal Reserve is starting to raise interest rates, and whenever that happens, winning and losing investments will follow. The U.S. central bank has already hiked rates twice, and after a strong July jobs report, the Fed will likely raise rates again, perhaps as early as next month. Investors are keeping an eye on the sectors that might benefit, although which ones depends on the reason for the rate hike.
In this case, the Fed is raising rates in response to economic growth, so sectors that benefit from an improving economy should outperform, market watchers say. The most likely winner, though, is the financial sector, as it has “a chance for significant acceleration,” says Doug Ramsey, chief investment officer for The Leuthold Group in Minneapolis. Many financial businesses stand to gain from both higher rates and the upward swing of the economic cycle.
Banks are the obvious but not the only winners in the financial sector. Higher rates will allow spreads to widen and profits to increase, says Bruce Bittles, chief investment strategist for Baird in Sarasota, Florida. The spread is the difference between what banks pay savers and what they charge borrowers, and it’s how banks make money, says Eric Ervin, chief executive officer of Reality Shares in San Diego. With rising rates, banks can charge borrowers more for a loan. It’s “an opportunity for them,” Ervin says.
[See: 11 Ways to Buy Bank Stocks.]
Although rates that are too high can discourage borrowing, “we’re a long way from there,” Ramsey says. The 10-year Treasury note would have to rise to 4 percent for banks to begin hurting, he says. The current yield for the 10-year note is around 2.37 percent.
In addition, there’s some doubt as to how much leeway the Fed has to raise rates. Bittles doesn’t expect the Fed to raise rates drastically because there is still so much debt left over from the credit crisis. Also, he says, an aggressive rate hike would likely cause the stock market to fall, potentially rippling out to hurt the economy, something the Fed may not want to risk.
Elsewhere in the financial sector, brokerage firms like Charles Schwab Corp. (NYSE: SCHW) and TD Ameritrade Holding Corp. ( AMTD) could also benefit from rising rates.
“They have enormous cash balances that are just sitting in money market funds,” Ervin says. “They haven’t been able to charge the fees (on the cash balances) because the interest rates were so low. If rates start to rise they can start charging those fees again.”
Plus, Ervin says, if the stock market continues to strengthen, people will “move money out of cash and start trading more,” generating more revenue for the brokerages.
Investors can get broad-based exposure to financials through a popular, liquid exchange-traded fund, the Financial Select Sector SPDR Fund ETF ( XLF).
Any pickup in the economy usually means more demand for commodities and other raw materials. Unlike financials, where the benefits from rising rates extend more broadly, the support for raw materials may be nuanced and vary by sector.
[See: The New Sector Funds: 10 Thematic ETFs.]
That’s the case for oil and the energy sector now. “Normally, rising rates helps the energy sector, but there are bigger issues going on with energy. You might not get the big assist from oil you normally get,” Ramsey says. He refers to the continued crude oil glut, which is weighing on oil prices.
Commodities like copper, which rallied this year, may continue to benefit from the strong economy. Copper can be traded via the futures market, or with an exchange-traded note. The biggest copper ETN by assets under management is the iPath Bloomberg Copper Subindex Total Return ETN ( JJC).
Also standing to gain from higher demand for raw materials in a strong economy are the materials and industrials sectors.
“You could see those sectors outperform,” Ramsey says.
If plans to improve infrastructure get through Congress, the materials and industrials sectors would benefit even further from an increase in federal spending, Ervin says.
Economic growth should also be a boon to information technology. Individuals and companies are more likely to spend money upgrading software systems and revamping older computer systems when times are good and the outlook for the economy is strong. Investors should look for IT companies with low debt because rising interest rates will hamper companies with heavy debt loads.
Bittles says investors may also want to consider hedging their bets with sectors that aren’t tied to higher rates, thereby building in a cushion for the inevitable downward shift in the economic cycle.
[See: 7 Stocks to Buy When a Recession Hits.]
“One sector that might be immune to a rise in rates is health care because it’s not as sensitive to the economy as others,” he says.
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These Sectors Should Gain From Rising Rates originally appeared on usnews.com
