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Why Fear Rising Rates? Play Cyclical ETFs

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Signs of a recovery, albeit moderate, in the U.S. economy, are now evident, thanks to the $1.9-trillion fiscal stimulus and vaccine distribution. Decent inflation, fast-improving corporate earnings, moderate retail sales and last but not the least President Biden’s upcoming infrastructure plans have been fueling optimism in the market.

Still, rising rate concerns are occasionally dampening the Wall Street rally. Although suddenly rising coronavirus cases may put off the bets over the withdrawal of Fed support sooner than expected, it is uncertain how long this speculation can be deferred. Wall Street bull Ed Yardeni expects inflation to rebound soon, as quoted on CNBC and this means a rise in long-term bond yields.

Should You Worry?

Probably not. The U.S. benchmark treasury yield has hovered around 1.42% to 1.74% this month with rates jumping 6 bps on Mar 29 from the previous trading day to 1.73%. The magnitude says that the value of yield is not strong enough to cause stock market crashes. In 2013, the U.S. benchmark treasury yield started the year with 1.86% while it ended with 3.04%.Notably, in 2013, the S&P 500 gained 30%.

Yardeni expects the current market conditions to increase the benchmark 10-year Treasury Note yield between 2.5% and 3% within the next 12 to 18 months. The economy and stock market are pretty strong to digest the increases in rates, per Ed Yardeni. He also expects growing productivity and technological innovation to keep cost pressures low and inflation tamed.

Even if there is steady rate hikes, we see no need to fear rising rate risks. The last full cycle of rate increases happened in the United States between June 2004 and June 2006 as rates progressively rose from 1.00% to 5.25%. Notably, Yardeni sees the S&P 500 year-end target as 4,300, suggesting an 8% gain from Friday’s close. For 2022, it’s 4,800.

Cyclical Sectors to Sizzle?

Historically, cyclical sectors outperform the defensive ones when rates normalize. In a growing economy, most sectors surge from a wealth effect, with a few of the more cyclical corners making the most of the rally. These industries often sag in a slumping economy but are the biggest winners during a revival.

Information Technology – ProShares S&P Technology Dividend Aristocrats ETF (TDV - Free Report)

Emerging new technologies like cloud computing, big data and Internet of Things are expected to pull the sector forward in the coming days. However, the sector is currently suffering from overvaluation fears and hence a dividend angle should be rewarding. 

Industrials – Industrial Select Sector SPDR ETF (XLI - Free Report)

An industrial boom is apparent in the U.S. economy, thanks to Biden’s infrastructure plans. The sector has suffered massively amid the pandemic. With millions of Americans still unemployed, the creation of blue-collar jobs would be of high priority. The latest recruitment pattern in the sector also calls for optimism.

Financials – SPDR S&P Bank ETF (KBE - Free Report)

A rising rate environment will lead to a favorable operating environment for financial stocks. Also, banking stocks offer value now. Banking stocks are highly cyclical as these are vulnerable to changes in economic conditions and policies.

Consumer Discretionary – Consumer Discretionary Select Sector SPDR Fund (XLY - Free Report)

The sector is likely to benefit from the rising income levels of consumers. U.S. consumer sentiment continues to rise in March, reaching its highest level in a year, per the University of Michigan's confidence index. Consumer confidence has improved as more people are getting vaccinated and business prospects have grown with many states easing restrictions. Though rising virus cases is a concern, we still do not expect any 2020-like crisis this year.

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