The self-styled philosopher kings and occupants of the Eccles
Building - the Federal Reserve governors - have divined
that easy money should be somewhat less easy.
Over the next eight months, the dials on quantitative easing
will gradually be turned down and finally clicked off by the end
of the year. By July 2015, interest rates will "officially"
rise when the Fed lifts the federal funds rate from zero to
somewhere north of zero.
Of course, this is all tentative and subject to change, as are
all bureaucratic proclamations. Nevertheless, the equivocating,
evasive, fine-print language of the newest Fed ringmaster,
, has most investors anticipating
rising interest rates
This anticipation, in turn, has inspired one of the more
frequent questions we encounter at
High Yield Wealth
these days: "How will rising interest rates impact
I wish I could offer a definitive answer; I can't. Stocks are
heterogeneous. A multitude of variables influence an individual
company's value and dividend payout. That said, we can game
which dividend payers might benefit and which might suffer in a
higher interest-rate environment.
First, we need to consider that rising interest rates are a
Rising interest rates are frequently a by-product of rising
economic growth. At the same time, rising interest rates
raise the cost of debt capital. The surge in share buybacks
in recent years has been fueled in large part by cheap
debt. When rates begin to rise, I expect to see fewer
buybacks, which will weaken price support for some stocks.
Fortunately, a growing economy supersedes low-borrowing costs
in the grand scheme of things. Economic growth is an obvious plus
for the overall stock market. But not everyone will
benefit: some stocks will outperform; others will lag.
will win. Tech companies tend to carry low debt load and a stable
fixed-capital structure. This paradigm frequently leads to
widening margins when sales accelerate. It also leads to rising
dividends. According to data analyzed by JPMorgan and Birinyi
Associates, tech stocks have historically been the best
performing sector in the six-months after interest rates begin to
Banking is another dividend-centric sector expected to
generate winners in a rising-rate environment. But again not
everyone will win.
If long-term rates rise and short-term rates remain near zero,
banks that lend long (mortgage lending, for example) and borrow
short will benefit. But if short-term rates rise with long-term
rates, banks with balance sheets festooned with assets sensitive
to short-term rates - home-equity loans, credit cards,
working-capital lines of credit - could be left in the dust.
Dividend growers might be the surest bet of all. These stocks
have historically outperformed in the wake of rising rates.
According to data compiled by Ned Davis Research, three years
after the Fed first hikes the federal funds rate, dividend
growers have outperform dividend nonpayers by over 17 percentage
As for potential laggards, keep an eye on sectors marked by
Utilities carry a lot of debt, and interest-rate worries weigh
on their share price. Master limited partnerships (
) carry high debt and could suffer if they need to refinance in a
higher-rate environment. Investors also need to keep an eye
, particularly if they own mortgage REITs, which are heavily
leveraged and carry interest-rate-sensitive assets.
Surprisingly, though, many REITs actually outperform when
rates rise. One investment firm reports that since 1979
there have been six periods of monetary tightening and rising
U.S. Treasury yields. When U.S. Treasury yields are rising (as is
happening now), REITs delivered average annual returns of 10.8%.
In periods when the Fed was actually increasing interest rates,
they performed even better with a 12.6% average annual gain.
High Yield Wealth
, business development companies, tech stocks - all of which
conventional wisdom expects to outperform when rates rise.
It also continues to hold energy MLPs and non-mortgage
REITs, which conventional wisdom expects to underperform, though
which we expect to perform. I say that because individual
security is key, whether interest rates are rising, falling, or
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