Don’t be afraid to invest when rates are rising
History shows S&P index often thrives
With a recent spike in borrowing costs causing swings in the market and angst on Wall Street, now might be a good time for investors to consider rejiggering their portfolios and shifting toward investments that fare better when interest rates are rising. A market-moving shift appears to be underway. The long period of historically low rates in place since the 2008 financial crisis – which enabled homebuyers to get cheap mortgages, car shoppers to obtain 0 percent loans and corporations to grow their businesses and profits with the help of cheap money – is reversing as investors and the Federal Reserve, reacting to an improving U.S. economy, push borrowing costs back toward more normal levels. The Fed has hiked short-term rates three times this year, raising its key rate – which it slashed to zero in 2008 – to a range of 2 percent to 2.25 percent. Adding to investors’ concern is the recent rise in the yield on the 10year Treasury note to above 3.25 percent, a seven-year high. Investors fear that higher rates will slow the economy and dent corporate profits. Those potential obstacles have caused increased market volatility on Wall Street in the past three trading sessions, with the Dow Jones industrial tumbling more than 340 points. It has also changed the outlook for many types of investments, ranging from stocks to bonds to real estate. As a result, “portfolios need to shift” to respond to the changing risk and reward profile of different investments, Michael Wilson, equity strategist at Morgan Stanley, wrote in a research report. Despite conventional thinking that rising rates are bad for stocks, historical data show that the broad Standard & Poor’s 500 stock index has actually posted strong returns. Stocks moved higher in 12 of the 15 periods since 1950 when the 10-year Treasury yield was rising, or 80 percent of the time, according to data from SunTrust Advisory Services. In fact, the S&P 500 posted average annualized returns of 12.6 percent during those 15 periods. Trying to pinpoint how high the yield on the 10-year note must climb before it becomes a major hindrance for the stock market is tough to decipher. Credit Suisse’s chief U.S. equity strategist Jonathan Golub cites 3.5 percent as a threshold to watch, while Lindsey Bell of Wall Street research firm CFRA cites 4 percent, and Bank of America Merrill Lynch says it would have to jump to 5 percent before bonds would look more attractive than stocks. The best companies whose stocks you should own when borrowing costs are rising are those without a lot of debt and plenty of cash on hand, says Brian Belski, chief investment strategist at BMO Capital Markets. His firm cited a list of stocks that fit this profile, including A.O. Smith, which makes water heaters, video game maker Electronic Arts, health insurer Humana and semiconductor giant Intel. Banks are also viewed as a good place to park cash when rates are rising, according to Belski. The parts of the market that normally feel the most pain when rates are rising are those investors seek out for income and which pay out sizable dividends, such as utilities, real estate and telecom, McMillan says. Rising interest rates also mean more expensive mortgages, which crimps affordability for prospective homebuyers. And if fewer people can afford homes, that could cause real estate prices to stagnate or fall, crimping the buildup in equity of current homeowners, analysts say.
Wall Street investors fear that higher rates will slow the economy and dent corporate profits.