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Beyond Utilities: 3 ETFs to Avoid when Rates Rise

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Fed rate hike speculations never looked as real before. In fact, it is no longer guesswork this time around, it looks like a verdict waiting to be sealed. First, the Fed talked about the possibility of a December lift-off in its October FOMC meeting, then it put more stress on a well-performing economy in early November and finally a bumper October job data report cemented the bet.

Markets hurried to price in the expected Fed move. Yields on bonds started to climb putting many investors on edge. While a 'great rotation' (from bonds to stocks) might be common in such a scenario, outright equity investing also looks risky. After all, an end of cheap money inflows and the dollar strength has the all ability to repeal the six-years of bull-run of equities.

n fact, high dividend paying stocks would be the worst hit given their sensitivity to rising interest rates. In fact, rising bond yields already took some steam out from dividend yield plays. This is forcing many investors to reevaluate their portfolios, pretty much across the board.

By now, every investor must have come to know about the beginning of the downtrend in the utility sector. Though highly safe, utilities suffer on its increased dependence on the interest rate policy. The sector requires huge infrastructure which places a massive debt burden and the resultant interest obligation on these companies.

This leaves the sector with no scope of outperformance in a rising rate environment. No utility ETF was in the green in the five-day period (as of November 11, 2015). The one-month performance was almost equally miserable. Weaker-than-expected Q3 earnings also dragged down the sector (read: Utility ETFs Slide on Weaker-than-Expected Q3 Earnings ).

However, apart from utilities, there are a few sectors which could behave in same fashion on lift-off issues. Below, we highlight three sector ETFs that could be the biggest losers from the rising rate scenario:

Real Estate

Real Estate is a highly interest rate sensitive sector. These firms are usually highly leveraged and face maximum interest rate risk in the REIT world. Now, REITs are required to distribute 90% of their annual taxable income through dividends which make them high dividend yield vehicles. With the declining income of REITs due to the impact of rising interest rates, the dividend yield will also fall along with returns.

This is why the largest REIT ETF Vanguard REIT Index ETF ( VNQ ) fell over 3.7% in the five trading sessions in contrast to about a 0.1% decline in broader market ETF SPDR S&P 500 ( SPY ). iShares Real Estate 50 ETF (FTY) was the worst performer from the five-day look, having lost over 4.3% (as of November 11, 2015).

Consumer Staples

Consumer staple stocks have been under stress in recent months as investors are slowly moving into the "riskier" corners of the stock market (i.e. cyclical stocks) and away from the defensive ones. This is because an improving economy, a recovering housing market and a perked up labor market should add to the "wealth effect", resulted in rising consumer confidence for the cyclical sectors. Moreover, the ongoing holiday season bodes well for the cyclical consumer discretionary stocks and ETFs (read: Q4 Outlook for Consumer Staples ETFs ).

Since staples stocks and ETFs are high yield in nature, these could be vulnerable to rising interest rates. Also, many consumer staple stocks are rich in global presence and are likely to underperform in a stronger dollar backdrop. The largest consumer staples ETF SPDRConsumer Staples Select Sector ETF (XLP) was the worst performer (down 1.7%) from the last one-week look.

Material

With the greenback gaining strength after the lift-off talks, metal prices started hitting lows . To make matters worse, Chinese economic concerns (the nation happens to be a key consumer of base metals) continue to undermine the metal prices. Though producers resorted to measures like production cuts to support metal prices, a stronger greenback is not helping the case.

Not only base metals, all commodities including agricultural products are presently displaying a dire stretch, on elevated supply, falling demand and a stronger dollar. Strong greenback turns commodities pricier as they are priced in that currency . All these crippled material ETFs lately. Vanguard Materials ETF (VAW) was one of the worst performing ETFs in the last one-week frame (as of November 11, 2015).

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ISHARS-RE 50 (FTY): ETF Research Reports

SPDR-CONS STPL (XLP): ETF Research Reports

VIPERS-MATERIAL (VAW): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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