Year 2018 so far has been marked by increased government borrowing costs. This is especially true as growing inflationary pressure is building up the case for aggressive rate hikes, pushing yields higher. According to CME, there is 51% chance of four interest rates hike this year.
The 10-year Treasury yields, which are a key driver of global borrowing costs, jumped to a 7-year high of 3.12%. The latest spike came on the heels of higher oil price, which is back to $80 per barrel level, and upbeat April retail sales. Worries about growing supply of government debt are also causing the spike in yields (read: ETF Strategies to Play the 7-Year High Benchmark Yield).
Pros and Cons
A rising rate environment is highly beneficial for cyclical sectors like financial, technology, industrials and consumer discretionary. Banks are at the most advantageous position as they seek to borrow money at short-term rates and lend at long-term rates. If interest rates rise, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits. Also, insurance companies are able to earn higher returns on their investment portfolio of longer-duration bonds.
Higher interest rates usually indicate a healthy economy, which in turn leads to greater consumer power. An improving economy coupled with higher consumer confidence is making the consumer discretionary sector tempting to investors amid higher yields. The technology sector should benefit as rising interest rates usually correlate with an economy that is gaining strength and is expected to grow at a faster pace, leading to increased IT spending (read: 5 Niche Tech ETFs Hitting All-Time Highs).
Although higher rates would attract more capital to the country, boosting the U.S. dollar against the basket of other currencies, it would have a huge impact on commodity-linked investments, implying that a rising rate environment will hurt a number of segments. In particular, high dividend paying sectors such as utilities and real estate would be the worst hit, given their higher sensitivity to rising interest rates. Additionally, securities in capital-intensive sectors like telecom would also be impacted by higher rates.
Further, higher rates would also result in tighter lending conditions and curtail consumer spending on a wide range of products like cars and houses. This will in turn dent profitability across various segments. Further, businesses will also face higher loan rates over time.
Given this, we have highlighted ETFs & stocks from the sectors that will benefit from higher rates and the ones that will be badly impacted.
Sectors to Win
The ultra-popular Financial Select Sector SPDR Fund (XLF - Free Report) , with AUM of $32.9 billion and average daily volume of 61.6 million shares, offers broad exposure to the sector with banks making up for 44.9% of the portfolio. The fund charges 13 bps in annual fees and has a Zacks ETF Rank #1 (Strong Buy).
With a market cap of $36.98 billion, State Street Corporation (STT - Free Report) is one of the leading providers of financial services to institutional investors, including investment servicing, investment management and investment research and trading. The stock has above industry average earnings growth estimate of 30.59% for this year. It carries a Zacks Rank #2 (Buy) and a VGM Score of B.
This Zacks #1 Ranked Consumer Discretionary Select Sector SPDR Fund (XLY - Free Report) offers exposure to the broad consumer discretionary space with key holdings in Internet & direct marketing retail. It has AUM of $13 billion and trades in an average daily volume of nearly 6 million shares (read: 6 ETFs to Ride On Amazon's Blowout Q1).
Global accessories, footwear and apparel company Michael Kors Holdings Limited (KORS - Free Report) has a Zacks Rank #2 (Buy) and a VGM Score of B. Its earnings are expected to grow 5.9% for this year. The stock has a market cap of $9.81 billion.
iShares U.S. Technology ETF (IYW - Free Report) provides exposure to U.S. electronics, computer software and hardware, and informational technology companies. With AUM of $4.1 billion and average daily volume of 250,000 shares, the fund carries a Zacks ETF Rank #2.
Lam Research Corp. (LRCX - Free Report) , which designs, manufactures, markets and services semiconductor processing equipment used in the fabrication of integrated circuits, has a Zacks Rank #1 and a VGM Score of A. It is expected to see above-industry earnings growth of 75.79% for this fiscal year (ending June 2018) and has a market cap of $33.17 billion.
Sectors to Lose
Schwab U.S. REIT ETF (SCHH - Free Report) , having AUM of $4.1 billion and average daily trading volume of 664,000 shares, offers broad exposure to real estate sector. It has a Zacks ETF Rank #5 (Strong Sell) with a High risk outlook.
With market cap of $19.57 billion, General Growth Properties Inc. (GGP - Free Report) is involved in owning, managing, leasing and redeveloping retail properties primarily in the United States. This #4 (Sell) Ranked stock is expected to post earnings decline of 0.64% for this year.
This Zacks #5 Ranked Vanguard Utilities ETF (VPU - Free Report) measures the investment return of stocks in the broad utilities sector. It has amassed $2.5 million in its asset base and trades in volume of 208,000 shares per day on average.
Edison International (EIX - Free Report) , a generator and distributor of electric power, is expected to post earnings decline of 10% for this year. It has a Zacks Rank #4 and a market cap of $20.05 billion.
iShares U.S. Telecommunications ETF (IYZ - Free Report) , carrying a Zacks Rank #4, offers exposure to U.S. companies that provide telephone and Internet products, services, and technologies. It has managed assets worth $320.3 million and sees volume of 350,000 shares a day on average (read: What Lies Ahead for Telecom ETFs?).
With a market cap of $9.38 billion, Juniper Networks Inc. (JNPR - Free Report) is the leader in enabling secure and assured communications over a single IP network. The stock is expected to see earnings decline of 15.17% this year and has a Zacks Rank #5.
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