The writing on the wall is clear. Recent economic data clearly shows that the tapering of the Fed’s economic stimulus program will begin soon. Key reports on unemployment and the service sector have firmed up the central bank’s basis to begin tapering the program by this month itself.
Encouraging economic data
The ISM Services Index is now at 58.6, increasing from the level of 56 it achieved in July. This is clearly higher than most expectations, which were around the 55 mark. More significantly, the index is at its highest level since December 2005. The service sector accounts for around 85% of the economy, and, as such, this is an extremely significant development.
Additionally, jobless claims numbers fell last week, by 9,000 to 323,000. This is the lowest level in almost five years. Despite other data on this front, the report points to a gradual improvement in the employment situation. Reductions in government spending and healthcare reform seem to have had little effect on the job market.
Resurgent Regional Banks
The consequence of such data and subsequent tapering of the Fed’s stimulus package has pushed up interest rates. The yield on benchmark 10 year U.S. Treasury bonds are close to the key level of 3%. Regional banks are some of the major beneficiaries of this development and many have outperformed larger players.
This is because many regional players such as Zions Bancorp. (ZION - Analyst Report), have a higher percentage of variable rate loans. As interest rates increase, this pushes up net interest margins. This is the difference between what banks have to pay depositors and the amount received from loans. Two key regional banks, U.S. Bancorp (USB - Analyst Report) and The PNC Financial Services Group, Inc. (PNC - Analyst Report) have recently reported higher earnings.
An Impetus for Insurers
Insurers had a tough time due to the low interest rate regime. This is because most insurance companies invest in bonds with longer maturity periods. With interest rates at all-time lows, they continued to lose money, since they had to hold onto such securities.
However, rising interest rates mean they could become excellent investments themselves. This provides them with an opportunity to take on a higher level of risk. Many of them could now pick up equity investments and bonds with shorter maturity periods. This could have an extremely positive impact on their yield curves. Undoubtedly, the insurance sector seems to be one of the major gainers of rising interest rates.
Mutual Fund Picks
Fidelity Select Insurance (FSPCX - MF report). Launched in December 1985, this is the oldest of our choices with net assets of $530.5 million. It has a minimum initial investment requirement of $2,500. The fund invests in companies whose principal operations are related to the insurance sector. It focusses on acquiring common stock, issued by both domestic and foreign companies.
The mutual fund holds 43 securities in all. It is heavily concentrated around its top 10 holdings, which make up 58.25% of its assets. Its top 3 holdings are Berkshire Hathaway Inc. (BRK-B), American International Group, Inc. (AIG - Analyst Report) and ACE Limited (ACE - Analyst Report). The fund returned 41.33% over the last one year period and has a Zacks Rank #1(Strong Buy).
John Hancock Financial Industries A (FIDAX - MF report). With net assets amounting to $518.12 million, this fund was founded in March 1996. This fund focussing on investing in domestic and foreign financial service companies regardless of their size. A maximum of 15% of its assets may be invested in short term securities rated investment grade.
This fund is more widely diversified and holds a total of 77 securities. Its top 10 holdings account for 29.22% of its assets. Its two top holdings are US Bancorp, followed closely by Ameriprise Financial, Inc. (AMP). Zions Bancorp is also among of its top 10 holdings. The fund returned 41.58% over the last one year period and has a Zacks Rank #1(Strong Buy).
Fidelity Select Banking (FSRBX - MF report). Another fund from the Fidelity stable, this is also the largest of our choices. Net assets of the funds amount to $592.51million. The fund concentrates on investments in the banking sectors. It primarily purchases common stock and utilises fundamental analysis to determine its investments, both domestic and foreign.
The fund has a total number of 55 assets. The asset it is most heavily invested in is U.S. Bancorp, which makes up 12.68% of its assets. It invests 4.95% of its assets in PNC Financial, its third highest holding. The fund returned 31.31% over the last one year period and has a Zacks Rank #1(Strong Buy).
With tapering more or less set to kick in by this month, a higher interest rate environment is inevitable. Since they invest in insurance and regional banks, these mutual funds are good choices for your portfolio.