It is the single question that's on the minds of most
investors. What is the impact on the stock market if interest
rates continue to rise?
My sense is that rising rates - off of a very low 0% Fed funds
rate - will not harm stocks.
After all, the major stock-market barometers - the Dow, the
S&P 500, the NASDAQ Composite - have all pushed forward to
achieve new highs after the June interest-rate spike. Sure -
stocks had pulled back briefly, but then resumed their climb.
If we take a more granular look, though, the answer is less
obvious. Stocks are heterogeneous, and the share prices of
companies in some sectors have recovered better than those in
The market rally has been mixed because rising interest rates
are a mixed blessing. Rising rates increase borrowing costs. But
they also increase opportunities in fixed-income investments,
which have suffered a dearth of opportunity in recent
Rising interest rates a sign of an improving economy. And the
best thing for U.S. companies is a healthy economy. A healthy
economy is far more important than low borrowing costs. And this
is an obvious plus for stock prices.
So who are the losers and winners when interest rates
Not surprising, sectors marked by high debt will likely
underperform. When debt matures and must be refinanced, the cost
to fund new debt rises and weighs on future earnings and dividend
For this reason, sectors carrying high debt levels have yet to
rebound with the stock market.
Utilities, for one, carry high debt levels, and interest-rate
worries continue to weigh on their share price. The Dow Jones
U.S. Utilities Index (DJUSUT) is down 1.5% from late April - when
interest rates first started to rise. In comparison, the broader
market S&P 500 is up 7.5%.
Similar underperformance is seen in other high-debt sectors.
Alerian MLP Index (
, concentrated in energy master limited partnerships, is up less
then 1% in the past three months. And the
Vanguard REIT ETF (
, a diversified commercial REIT fund, is still 2% below
I'm not suggesting that investors sell MLPs or REITs. The
High Yield Wealth
portfolio continues to own energy MLPs, REITS, and utilities. But
I'm focused on investing in individual stocks, not
that follow these sectors.
I still like these "loser" investments because of their
individual characteristics and advantages. But in a rising-rate
environment, I'm monitoring them a little more closely.
As for the other side of the ledger, banks are perceived as
rising-interest-rate winners. But there is one caveat: Banks are
winners as long as rates are rising but not inverting. Banks lend
long-term but borrow short-term through customer deposits. When
the spread expands, as it has in recent months, margins are
projected to widen and earnings and dividend payouts are
projected to rise.
When interest rates took flight in late April, banks stocks
soon followed. Investors, anticipating improved performance, have
already bid up the KBW Bank Index (
) nearly 20% in the past three months.
Technology stocks are also expected to outperform. Most tech
companies have low debt and a stable fixed-capital structure,
which leads to widening margins when revenue grows. In fact, the
technology sector has historically been the best performing
sector in the six-months after a rise in interest rates,
according to data analyzed by JPMorgan and Birinyi
Though not a sector per se, I'd be remiss not to mention my
favorite investments - dividend growers.
SPDR S&P Dividend ETF (
is a fund composed of S&P 1500 stocks that have raised their
dividends annually for at least 25-consecutive years. It's up 6%
since late April.
I'm not surprised. If there is one investment strategy for all
seasons, it's a dividend-growth strategy. Whether investing in
dividend growers through an ETF or by owning individual stocks
like Altria or McDonalds, this is a tried and true strategy that