Rising interest rates are being portrayed as the bogeyman, and certainly, higher rates can pose challenges to some aspects of one’s investment portfolio. However, they also present opportunities in many stock market sectors. The secret is that some of these sectors are already experiencing money inflows as the bear market in bonds has resumed. Many investors are deciding to ditch bonds and shift to stocks or money markets. Though, as experience has shown, when rates rise there are potential benefits of investing in value stocks, or in sectors like materials and energy.
With strategic sector allocations and a focus on companies with strong fundamentals, investors can embrace the new thinking on higher long-term interest rates by tailoring their stock selection.
The Bear Market Is in Bonds, Not Stocks
Mathematically, when interest rates rise, the value of existing bonds decreases. For bondholders, there’s no escaping this reality. For instance, if you hold a bond yielding 4% and rates increase to a more attractive 4.75%, your existing bond becomes less appealing. As a result, the market price of the 4% bond drops until its yield aligns with the current market rate of 4.75%. This is why bond investors, who anticipate that there will be further rate hikes, are divesting.
Furthermore, there is no shortage of headlines and experts predicting further increases in U.S. interest rates. Consequently, assets migrating from bonds must seek alternative avenues where the risk of losing money due to rising rates is less certain. In other words, they need investments with a higher probability of yielding positive gains. Many of these expert voices are advocating for stocks in specific sectors.
Experts Lean Toward Stocks
The smart money isn’t fleeing from equities; in fact, there is evidence that sophisticated market watchers are recommending positions in specific stock sectors for this new climate. After all, stocks have just weathered two years of one of the most aggressive bond bear markets in history, driven by rising interest rates.
As a result, there is now a record amount of assets held in money market funds, while another portion is flowing into the stock market for refuge. As reported by MarketWatch, many investors are seeking shelter in equities, particularly in the value category. These are companies trading at a discount compared to their intrinsic worth, and they often perform well when interest rates rise. Investors can think of it as finding a sale that provides good value for the price.
The Financial Times, owner of the Russell Indexes, suggests that sectors like materials and energy, whose products tend to rise in price during inflationary periods (which is the impetus for U.S. rates increasing), could also experience a boost. Therefore, stocks used in manufacturing or providing energy could potentially enhance and energize an equity portfolio as rates are on the rise.
Of course, navigating a changing interest rate environment requires a steady hand. As The Wall Street Journal suggests, some volatility is to be expected. However, by strategically considering your sector allocations and focusing on companies with strong fundamentals, you can potentially turn this period of transition into an opportunity.
SPDR industry ETFs have been selected for this illustration to represent the three main sectors, including value, energy and materials. The term ‘value’ typically refers to companies that are considered undervalued relative to their fundamentals, such as their earnings, dividends, and book value. These sectors have been highlighted across several newspapers as promising areas to explore when rates are rising.
According to the TipRanks ETF Comparison tool, these ETFs have low expense ratios by industry standards, with two boasting smart scores of eight and one slightly lower at 7. Investors can customize this tool to compare similar and dissimilar ETFs until they find ideal candidates for their own rising rate strategy.
Key Takeaway
Rising interest rates do present challenges for investors; after all, it means the playing field is changing. You can’t do anything about it, so you must change along with it. Remember that higher yields also open doors to new strategies and investment approaches. Perhaps heed the advice above related to sectors such as materials and energy that tend to perform well in inflationary periods. Or consider maintaining a diversified portfolio that includes value and dividend stocks, in addition to growth stocks. It’s possible that investors can pivot and turn any interest rate environment to their advantage.
