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September 12, 2015

2 Sectors To Consider When Rates Rise

While the recent market selloff and declining inflation expectations have lowered the probability of a September Federal Reserve (Fed) rate rise, “good enough” U.S. economic data still support Fed liftoff occurring later this year. However, the exact timing of the hike—September, December or even early 2016—isn’t as important as the market implications of moderately higher rates, which are expected to come sometime soon.
 
Though the Fed is likely to raise rates gradually, higher short-term rates will ripple through the markets and affect a wide range of financial assets, including stocks.
 
The actual liftoff event will most likely lead to more short-term U.S. stock market volatility, so investors should expect a continued bumpy ride in the months ahead. That said, I do see potential opportunities in two particular U.S. sectors.

Two Sectors to Consider

Technology Sector

Technology companies hold a staggering 40 percent of the total corporate cash reserves in the U.S., according to Forbes, so they’re much less vulnerable to rising rates than debt-laden firms, such as utilities, according to Bloomberg data as of 07/13/2015. Their strong cash positions mean they have the potential to continue on with their shareholder-friendly policies, such as share buybacks, dividend increases and M&A activity. In addition, while tech valuations have risen in recent months, current levels suggest that there may be additional room to run. As of last month, tech companies, as measured by the S&P 500 Information Technology Index, traded with a 6 percent price-to-earnings (P/E) discount to the S&P 500, well below the trailing 10-year average of a 12.7 percent P/E premium, according to Bloomberg data.

Financials Sector (excluding rate-sensitive REITs)

For some financial institutions, namely banks, higher rates could potentially translate into higher revenues. In an environment of rising rates, the difference between what banks make from lending (their revenue) and what they pay for deposits (their costs) may increase, so banks potentially stand to increase profits. In addition, in anticipation of higher rates, many banks have begun to reposition their balance sheets toward variable rate loans, so they won’t be locked into low interest rates, and they’re hedging their interest rate exposure, according to banks’ most recent earnings reports and earnings calls with analysts.
 
It’s also worth noting that U.S. financials were the bright star of second-quarter earnings—roughly 60 percent of financials beat revenue expectations, well above the overall sector average, according to Bloomberg data. Beyond strong earnings, financials also represent a relative bargain compared to some other sectors. For instance, the financial sector is still among the cheapest S&P 500 sectors in both P/E and price to book (P/B) terms, and its P/B ratio is just half that of the broad U.S. market, according to Bloomberg data.
 
Finally, both U.S. technology and U.S. financials are cyclical sectors. When the economy is strong, as it tends to be in a rising rate environment, cyclical stocks typically outperform. In contrast, defensive sectors (think utilities) tend to outperform the broader U.S. market when economic growth slows, and as rates rise, they can be vulnerable, given that they may have significant debt loads.
 
Exchange traded funds (ETFs), such as the iShares U.S. Technology ETF (IYW) and the iShares U.S. Financial Services ETF (IYG), can provide access to the U.S. Tech and U.S. Financials ex-REITs sectors.
About the Author: Heidi Richardson is a Global Investment Strategist at BlackRock. She is also Head of Investment Strategy for U.S. iShares. 

 


The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

 
Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal. Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market. Technology companies may be subject to severe competition and product obsolescence. Performance of companies in the financials sector may be adversely impacted by many factors, including, among others, government regulations, economic conditions, credit rating downgrades, changes in interest rates, and decreased liquidity in credit markets. This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular. The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision. This material does not constitute any specific legal, tax or accounting advice. Please consult with qualified professionals for this type of advice. This document contains general information only and does not take into account an individual's financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision. The Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”). ©2015 BlackRock, Inc. All rights reserved.iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc.. All other marks are the property of their respective owners.   iS-16450




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