US Fed meeting could trigger stock sector rotation
NEW YORK (Reuters) – US equity investors could rotate out of high-yielding sectors and into stocks of banks, which would benefit from the next leg up in interest rates, after the Federal Reserve’s policy-setting meeting wraps up on Wednesday.
If the Fed this week gives a nod to rising inflation or focuses its trimmed-down bond buying on longer-dated bonds as it winds down its balance sheet, there could be a shift around of preferred sectors, investors said.
“In the short run financials will benefit,” said Chad Morganlander, portfolio manager at Washington Crossing Advisors, if the Fed action pushes long-term rates higher relative to short-term rates.
This week’s meeting is not expected to result in an interest rate increase, but investors will focus on how Fed chair Janet Yellen characterizes recent inflation readings, for clues to the likelihood of a hike in December, as well as on how the US central bank will begin to wind down its $4.5 trillion balance sheet.
Inflation has been persistently low but Yellen could dismiss this as transitory and point to recent stronger-than-expected data on consumer prices.
Any heightened expectations of a rate increase could fuel a rotation and “will certainly change leadership” among market sectors, favoring financials, industrials and materials, according to Jim Paulsen, chief investment strategist at The Leuthold Group in Minneapolis.
“It would put pressure on utilities and telecoms” as well as on companies that consistently increase quarterly paybacks to shareholders, he said.
Investors typically sell shares of utilities and telecoms as well as high dividend payers when interest rates rise, partly because they lose their appeal as bond proxies since investors can expect similar returns investing in bonds, which are seen as safer assets.
So far this year, the S&P 500 banking index is up less than four percent, underperforming the 9.2 percent gain in the S&P 500 dividend aristocrats index S&P 500 utilities are up 12 percent.
While the Fed’s expected announcement of the trimming of its balance sheet has been well telegraphed, investors will look for any Fed reveal on its preference for shorter- or longer-dated bonds when it reinvests a portion of its maturing assets.
If the focus is on the repurchase of short-term assets, that would likely push the long end of the yield curve higher, driving investors’ attention also to shares of banks, which would theoretically make more money with the help of higher net interest margins, said Morganlander.
Banks borrow money short term and lend it out longer term, so a steeper yield curve is seen as positive for their balance sheets.
However, long-term yields in the US are not immune to the effect of low-yielding bonds in other developed countries like Germany and Japan.
“The general tendency based on global rates will continue to pressure the yield curve,” Morganlander said.
While the Fed’s quantitative easing program was a pillar of the US stock market’s march from then-12-year lows on the S&P 500 in 2009 to current record-high levels, winding it down is not expected to produce a major market reaction on the downside.