The old saying “When rates are low, stocks will grow, and when rates are high, stocks will die” is about to be tested for truthfulness in a dramatic way.
The last six years have seen interest rates held unnaturally low by the Federal Reserve. Ultra low-interest rates have resulted in a massive bull market and a surge in economic activity across the board. Now, things are about to change!
Signals are brewing in the economy and directly from the Federal Reserve itself that interest rates are about to begin climbing higher.
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In fact, multiple analysts identify September as the month that the Federal Reserve will make its first move increasing rates.
Just like the old saying above, historically, stocks have suffered in economic regimes of climbing rates.
The real question is, is your portfolio prepared for the climbing rates?
Fortunately, we have identified a single sector that we expect to reap huge benefits from advancing interest rates. In fact, the higher rates go, the more profits this industry will earn. I know this flies in the face of traditional wisdom, but it makes perfect sense.
Before we talk about the sector and how you can profit from the pending interest rate increases, let us take a closer look at what is happening that will force rates higher.
Currently the economy is experiencing higher core inflation combined with a low unemployment rate. The employment rate dropped to 5.4% in April, the lowest it has been since 2008. Also, wages are slowly ticking higher, and the housing market is on fire in many regions of the country.
Royal Bank of Scotland chief economist, Michelle Girard explained to CNBC’s “Squawk Box” program that the low unemployment rate is making the Fed uncomfortable with leaving interest rates at zero.
She stated “They may disagree on whether interest rates should be 1 or 2%, but more and more members on the committee feel that sitting at zero … is probably not right.”
Peter Boockvar, Lindsey Group’s chief market analyst, added on the “Squawk Box” program, “The problem now with the Fed is that, with this 2 percent [annual] growth rate, we may have a 4-handle on the unemployment rate in the second half of the year. Their long-term forecast … is 5 percent, [and] we have core inflation ticking up. So, the Fed’s going to be put into a situation in which, with 2 percent growth, they’re going to have to start raising rates.”
The Federal Reserve has added to the interest rate increase fire when the San Francisco Fed President John Williams explained to Reuters, “We’re going to be…likely raising interest rates later this year, increasing them gradually over the next few years.” He added, “I have an FOMC meeting coming up in several weeks. I don’t need to make decisions today. Collect some more data, get some more information, have discussions and analysis.”
It’s important to note that The Fed’s post-April meeting policy statement pointed out that the central bank has established a meeting-by-meeting approach on the timing of its first rate hike since June 2006. The Fed has made clear that the pending interest rate hike will be strictly data-driven.
Now that we have established that interest rates will soon be climbing higher, how should stock investors react?
While there is no certainty regarding how the interest rate increase will affect stock prices; a particular sector will benefit from the rate increase. Well-informed stock investors are already busily fortressing their portfolio with these stocks to help from the soon to climb interest rates.
In case you have not guessed it, the sector that stands to benefit the most from climbing interest rates is the banking sector.
Because this is the fact that higher short-term rates will allow banks to earn greater returns on their holdings.
Over the last six years, the ultra-low rates have both hurts and helped banks. Nevertheless, the help side is much more dramatic than the hurt side. While it has lowered the bank’s borrowing costs, it has slashed what they can charge on loans and earn on investments. The Difference between these two factors known as the net interest margin has been downward trending since 2010
Bank of America, explained to Bloomberg, the sustained low-rate environment is hitting revenue and earnings.
The way it works in real life is when rates increase, lenders try to raise interest rates on loans faster than interest rates they pay our on deposits. The difference is profit, and this is why higher rates will help the banking sector.
We already see the buying, in preparation for higher rates, hit the banking sector. The SPDR Bank ETF (NYSE:KBE) is up 3.5% just in the last 30 days. This ETF is a wise choice for those investors who wish to Fortress their portfolio against rising interest rates. What I like best about this ETF is it represents both national money center banks and regional banks. The reason being is that rising interest rates will benefit both regional and national banks but in different ways.
While both sectors of the banking industry will benefit, national banks stand to benefit from credit card and other broad consumer lending as rates increase. At the same time, regional names stand to profit from mortgages and business loans whose rates will increase. It is important to keep in mind that the ETF is weighted toward region banks with 40.4% of its holdings in the regional bank sector.
Drilling into the particulars, the S&P Banks Select Industry Index is a modified equal-weighted index that seeks to reflect the performance of publicly traded companies that do business as banks or thrifts. The Bank Index is currently comprised of common stocks of national money centers and leading regional banks or thrifts listed on the NYSE or another U.S. national securities exchange, or NASDAQ®/National Market System (“NMS”). The Bank Index components are selected to provide appropriate representation of the industry’s sub-sectors.
This graphic clearly reveals the holding and sector breakdown of the KBE banking ETF.
Add in the fact that this ETF pays out a respectable 1.94% dividend, and it creates a compelling investment case.
Here is a closer look at the technical picture.
As you can see, major technical support exists at the $30.00 per share zone. Price is pushing higher and is solidly above both the 50-week and 200 week simple moving averages. Placing a buy order fractionally above $35.00 per share at $35.07 would be our suggested entry point. Initial stops should be set at $33.37 per share and the target price is $41.60 per share.
The Key Takeaways:
There is little doubt that interest rates will be climbing soon. The evidence is very strong from both the Federal Reserve’s statements and the economic situation. In fact, leading analysts believe that the Fed may be forced to increase rates due to the economic picture sooner than planned.
Despite climbing interest rates creating strong headwinds for the bull market, the banking sector is expected to benefit from higher interest rates. Wise investors are fortressing their portfolio by purchasing bank shares.
The easiest and smartest way to gain exposure to the banking sector is via the SPDR bank ETF (NYSE:KBE). This ETF provides instant diversification across both regional and national banks.