Minutes of the Federal Reserve’s September 19-20 meeting showed that ‘many’ officials favor a rate hike later this year as the economy continues to expand at a steady clip. Fed officials added that the adverse effects of hurricanes on the economy are likely to be temporary.
The continuation of weak inflation, however, was the dominant topic. Policymakers believed that softening of inflation was mostly due to one-time factors, the effects of which are expected to fade over time. They were confident that the desired inflation target will likely be hit soon. Fed Chair Janet Yellen, in the meanwhile, admitted that inflation remaining below the desired level is a dilemma. She, however, assured that soft inflation doesn’t mean the Fed needs to wait for the price pressure to pick up before raising rates again.
This calls for investing in banks, insurance and brokerage houses as such institutions will see a ramp up in profits on an interest rate hike and stable economic conditions.
Is a December Rate Hike in the Cards?
The Fed panel, which sets U.S. monetary policy, sees possibilities of a hike in December on steady expansion in the economy. The U.S. economy is growing close to the range expected by President Trump and some other Republicans, while both manufacturing and service sectors accelerated at a record pace in September.
A clearer view of last month’s labor market data shows that keeping the effects of the hurricanes aside, the U.S. employment scenario is continuing to tighten. In fact, policymakers believe that the economic effects of hurricanes Harvey, Irma and Maria, which ravaged through U.S. land masses between August and September, were only for the short term. They added that rebuilding has ramped up and economic activity has resumed.
Fed officials also said that business houses “appeared to have become more confident about the economic outlook,” while the Citi Economic Surprise Index improved after hitting multi-year lows in the summer.
At the meeting, the Fed officials left rates untouched at their current range of 1% to 1.25%. Additionally, they forecasted one final rate hike this year as well as three more in the next year. Wall Street is currently pricing an almost 90% chance of a rate hike by the end of the year, per CME Group data.
Can Inflation Be a Deterrent?
Persistently weak inflation did raise questions over further rate hikes. However, Kansas City Fed President Esther George said that “low inflation, in itself, is not a problem in an economy that is growing and operating at full employment.”
In fact, most of the Fed officials believe that with jobless rate at a 16-year low, price pressures is likely to build up to the 2% target rate in the medium term. Cost of goods is also likely to increase on an uptick in wage growth. Wages have increased 0.5% to average of $26.55 an hour in September, per the Labor Department data. In fact, in the last 12 months, hourly pay increased 2.9%, up from 2.7% in the prior month and also in line with a post-recession high.
Who Stands to Benefit?
Higher interest rates can boost bank profits as they increase the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities. The spread between long-term and short-term rates also expands during interest rate hikes because long-term rates tend to rise faster than short-term rates (read more: 5 Top Bank Stocks to Buy Ahead of Q3 Earnings).
Non-banking financial institutions including insurance companies, asset managers and brokerage firms should also benefit. Rising rates act as a boon for insurance companies as they 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 hike in Fed fund rates and bank interest rates. This enables life insurers to invest their 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 gain from a higher rate environment.
Brokerage firms and asset managers also advantage immensely from a rising rate environment since an increase in rates generally concurs during periods of economic strength and upbeat investor sentiments.
5 Solid Picks
Given the aforementioned benefits, we have selected five sturdy stocks from these areas that boast a solid Zacks Rank #1 (Strong Buy) or 2 (Buy). The search was also narrowed down with a VGM Score of A or B. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three metrics. Such a score allows you to eliminate the negative aspects of stocks and select winners.
Stifel Financial Corp (SF - Free Report) is a financial holding company. Its principal subsidiary is Stifel, Nicolaus & Company, Incorporated, a retail and institutional wealth management and investment banking firm. Stifel Financial has a Zacks Rank #1 and a VGM Score of B. The company is expected to return 41.8% this year, more than the Zacks Financial - Investment Bank industry’s projected return of 9.6%. Stifel Financial yielded a solid return of 38.9% last year.
Banco Santander, S.A. (SAN - Free Report) is a retail and commercial bank. The bank’s segments include Continental Europe, the United Kingdom, Latin America and the United States. Banco Santander has a Zacks Rank #2 and a VGM Score of A. The company is expected to return 22.2% this year, higher than the Zacks Banks - Foreign industry’s estimated return of 12.2%. Banco Santander outperformed the industry in the last year (+56.5% vs. +31.6%).
American Equity Investment Life Holding (AEL - Free Report) is engaged in the development and sale of fixed index and fixed rate annuity products. The company issues fixed annuity and life insurance products through its life insurance subsidiaries. American Equity Investment has a Zacks Rank #2 and a VGM Score of A. The company is expected to return 84.8% this year, more than the Zacks Insurance - Life Insurance industry’s projected return of 12.7%. American Equity Investment outperformed the industry in the last year (+67.9% vs. +33.3%). You can see the complete list of today’s Zacks #1 Rank stocks here.
Radian Group Inc (RDN - Free Report) is an insurance holding company that provides mortgage insurance, and products and services to the real estate and mortgage finance industries. The company has a Zacks Rank #2 and a VGM Score of B. The company is expected to return 10.7% this year, more than the Zacks Insurance - Multi line industry’s estimated return of 3.9%. Radian Group outperformed the industry last year (+38% vs. +23.6%).
OM Asset Management PLC (OMAM - Free Report) is a global, diversified, multi-boutique asset management company. The company has a Zacks Rank #2 and a VGM Score of A. The company is expected to return 28.9% this year, better than the Zacks Financial - Investment Management industry’s projected return of 8.1%. OM Asset Management yielded a return of 10.1% last year.
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