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Fed Set to Raise Rates Again: Top 5 Winners

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The Federal Reserve meeting today will be watched closely to see what the central bank does now and what it says about the future path of rates. The Federal Open Market Committee members are presently sounding hawkish, with policy makers being widely expected to hike rates by 25 basis points at the meeting and signal at a more aggressive path of increases.

This calls for investing in banks, insurance and brokerage houses as such institutions will see a ramp up in profits on steady interest rate hikes.

Fed Gears Up for Third Hike This Year

Ask any market pundit whether the Fed will hike interest rates at its Sep 25-26 meeting and the answer is an inevitable “of course”. In fact, traders expect a 100% hike on Sep 26 and an 83% chance of another increase by the end of the year, which is in line with the Fed’s dot plot from June meeting, according to CME’s FedWatch.

 

Thus, Chairman Jerome Powell and his colleagues on the FOMC meeting are widely expected to raise benchmark short-term federal funds rate by a quarter percentage point to a range between 2% and 2.25%, which will be the highest since 2008.

Why Will the Fed Raise Rates?

Some expect the economy to deteriorate in the near term, partially due to the adverse effects of conflicts that the United States have with China, Canada, Europe and various other trading partners. The benefits of tax cuts that took effect this year coupled with an uptick in government spending are also expected to fade.

But, let’s admit the current tight labor market conditions warrant a steady rate hike. The jobless rate remained at an 18-year low of 3.9% in August, while the economy added jobs for the 95th straight month. However, several business houses did complain that they can’t find skilled labor and may need to raise wages considerably to draw and retain skilled labor.

Wage growth, in fact, increased at the fastest pace last month since 2009, while some economists now expect wage growth to top 3% within a few months. And by early next year, it could edge toward this century’s highest mark of 3.6%. The average wage paid to American workers has increased by 10 cents to $27.16 an hour last month. To top it, the yearly pay rate climbed to 2.9% from 2.7%, the highest since the end of the Great Recession. Thus, accelerating wages will prompt the Fed to keep tightening credit to ensure that the economy doesn’t overheat.

 

Powell added that inflation is close to the central bank’s 2% target for the first time in several years and that the economy is expanding at a “solid pace”, justifying the interest rate hikes.

The economy, as measured by GDP, is positioned to expand 3% this year. This would mark the strongest full-year gain in nearly 13 years. In the last nine years of economic expansion, annual GDP growth averaged only about 2.2%.

Winners in a Rising Rate Environment

Now, which areas are set to make the most of a rate hike? Of course, financials! Banks are definitely the go-to rate trade now. As a rule, higher interest rates boost bank profits as they increase the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities.

National banks like the Bank of America Corporation (BAC - Free Report) are very rate-sensitive and have consistently seen earnings rise on a quarter-point rate hike.

Very few companies root for a rate hike as much as those in the insurance industry. This is because the relationship between interest rates and insurance companies is linear and straightforward, meaning the higher the rate, the greater the growth.

Insurers derive their investment income from investing premiums, which are received from policyholders in corporate and government bonds. Yields and coupons on these bonds rise in response to a rise in Fed fund rates and bank interest rates. This enables life insurers to invest premiums at higher yields and earn more investment income, expanding their profit margins.

Not only investment income, which is an important component of insurers’ top line, annuity sales should also benefit from a higher rate environment.

Brokerage firms advantage significantly from an increasing rate environment since a hike in rates generally occurs during periods of economic strength and upbeat investor sentiments.

Notably, a wealth management firm like The Charles Schwab Corporation (SCHW - Free Report) has said time and again that each quarter point increase in rates generally adds to interest revenues, much of which flows directly to pre-tax profits.

Top 5 Picks

Given the aforesaid positives, we have selected five solid stocks from these winning areas that boast a Zacks Rank #1 (Strong Buy) or 2 (Buy).

Blue Hills Bancorp, Inc. operates as the bank holding company for Blue Hills Bank that provides financial services to individuals, families, small to mid-size businesses, government, and non-profit organizations in Massachusetts. The company currently has a Zacks Rank 1. In the last 60 days, one earnings estimate moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 8.7% in the same period. The company’s expected earnings growth rate for the current year is 78.6% compared with the Banks - Northeast industry’s estimated rally of 22%.

American National Bankshares Inc. (AMNB - Free Report) operates as the bank holding company for American National Bank and Trust Company that provides financial products and services. The company currently has a Zacks Rank 2. In the last 60 days, one earnings estimate moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 2.2% in the same period. The company’s expected earnings growth rate for the current year is 31.9% compared with the Banks - Southeast industry’s expected rise of 31.3%.

Berkshire Hathaway Inc. (BRK.B - Free Report) provides property and casualty insurance and reinsurance, as well as life, accident, and health reinsurance. The company currently has a Zacks Rank 2. In the last 60 days, three earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 12.5% in the same period. The company’s expected earnings growth rate for the current year is 68.9% compared with the Insurance - Property and Casualty industry’s projected rally of 22.9%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Fidelity National Financial, Inc. (FNF - Free Report) provides title insurance, technology, and transaction services to the real estate and mortgage industries in the United States. The company currently has a Zacks Rank 2. In the last 60 days, one earnings estimate moved up, while none moved down for the current year. The Zacks Consensus Estimate for earnings rose 0.7% in the same period. The company’s expected earnings growth rate for the current year is 24.2% compared with the Insurance - Property and Casualty industry’s projected rally of 22.9%.

Lazard Ltd (LAZ - Free Report) operates as a financial advisory and asset management firm. The company currently has a Zacks Rank 2. In the last 60 days, one earnings estimate moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 1.1% in the same period. The company’s expected earnings growth rate for the current year is 21.2% compared with the Financial - Investment Management industry’s projected rally of 4.2%.

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