Buckle up and mark your calendars for Dec 16! Chances are high that the interest rate is going uphill.
Janet Yellen, the Chair of the Board of Governors of the Federal Reserve, is confident that the current stability witnessed in the U.S. economy will enable it to brave the onslaught of a raised interest rate. Moreover, a solid 97% of business and academic economists (surveyed by the Wall Street Journal) had predicted the hike. Consequently, investors are betting big in favor of the rise, which will be effective once the Fed announces the rate tomorrow.
In simple economics, this would be dire for the investment world, but in reality several dynamic factors play a critical role. Central banks’ raising their interest rates to spur economic growth and control escalating inflation rates is one such feature.
Going forward, however, the hike may create some turbulence in the U.S. economy. The impact may even spill over to the global stock market. That said, not all sectors across the economy will face the same amount of heat of this interest hike.
It has been observed historically that rate hikes boost stock returns. According to an article in money and markets, “if we look at the the last six Fed Funds rate tightening cycles, the S&P 500 Index posted above average gains of 9.8% on average nine months after the first Fed rate hike. That’s well ahead of the average 9-month gain of 7.2% for all periods going back to 1983.”
Thanks to the recent growth in the U.S. labor market that has lowered unemployed workers’ rate per job opening to 1.5 from 6.0 (in 2010), the purchasing power of U.S. citizens has gone up reasonably. This has naturally pushed up domestic spending by 3%. Given such positive trends, we believe, investors will not be shy to spend on sectors that exhibit strong fundamentals. To add to that, these sectors are expected to grow further, as rising rates signal robust economic growth.
In fact, sectors like Finance, Technology and Consumer Discretionary have historically shown strong positive correlation to interest rates. Read on to know why we consider these sectors our favorites.
Finance: Banks and other non-banking financial institutions like insurance companies and brokerage firms tend to benefit handsomely at times of surging interest rates. This is because borrowers taking up money from banks have to pay higher interest rates under such circumstances, which in turn shoots up income for the banks.
Moreover, as a rising interest rate depicts a healthier version of an economy’s growth, there will be lesser non-performing assets for the banks. An improved economic health dividend in the sector will thus induce investors to spend their money in insurance companies and brokerage firms at lesser risk rates.
We have zeroed in two such potential stocks in this sector that sport a Zacks Rank #1 (Strong Buy) or 2 (Buy), and have projected EPS growth and projected sales growth rates in excess of 10%.
While CBRE Group, Inc. CBG holds a Zacks Rank #2, projected EPS growth rate for the stock is 20.6% (compared to the industry average of -8.8%). Projected sales growth for the company is 18.4% (0.00%).
Similarly, Extra Space Storage Inc. EXR, carrying a Zacks Rank #2 has a projected EPS growth rate of 19.5% (7.7%), while projected sales growth stands at 17.9% (8.5%).
Consumer Discretionary: Consumer Discretionary is a diverse sector that includes nonessential goods and service providers ranging from auto makers, casinos and homebuilders to apparel retailers, specialty retailers, cruise line companies and others. Notably a central bank raises interest rate in the backdrop of an improved economic scenario along with better level of employment opportunities, which in turn reflects growth in the overall purchasing power of the economy.
A cyclical sector like Consumer Discretionary has historically performed well in periods of economic prosperity and growth, even in the wake of a high interest rate. We believe, if the Fed hikes the interest rate tomorrow, it will have no negative impact on this sector, at least for the time being. Further, with brighter prospects in the employment market today promising better pay and job security, the sector is likely to see increased consumer spending.
Considering similar selection criteria as before, we have gems like NIKE, Inc. NKE and Electronic Arts Inc. EA in the Consumer Discretionary space.
While NIKE, with a Zacks Rank #2, projects EPS growth of 15.5% (compared to industry average of 13.9%) and sales growth of 6.8% (1%); Electronic Arts, with a Zacks Rank #1, projects EPS growth of 33.7% (-11.1) and sales growth of 19.7% (-5.7%).
Technology: Technology – another cyclical sector – has also shown positive correlation with interest rate momentum. Large companies in this sector like Apple and Alphabet should remain unaffected by the Fed rate hike by virtue of their substantial cash reserves and successful business models.
Moreover, these technology giants do not rely on debt financing. Although a few tech start-ups may feel the heat of the Fed rate hike, the technology sector, overall, is expected to shine post the rate hike as it is essentially not a capital-intensive sector.
Based on the same criteria, we have handpicked two popular stocks from the Technology sector: Facebook, Inc. FB and LendingClub Corp. LC.
Facebook, with a Zacks Rank #2, projects EPS growth of 11.9% (compared to industry average of 1.7%) and sales growth of 40.2% (8.6%); whereas LendingClub, with the same Zacks Rank, projects EPS growth of 100% (1.7) and sales growth of 100.1% (8.6%).
The Bottom Line
After months of nail-biting speculations, finally the much anticipated Fed rate hike is set to roll. Whether this hike will have a rattling effect on the U.S. economy or not, is the big question. For now, we believe, these three sectors look to stand the test of time on the back of robust growth potential and a forward-looking American economy.
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