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Fed Finally Hikes Rates: Quality ETFs & Stocks to Buy Now

After a long wait, the Fed finally took a historic turn by exiting the loose monetary-policy era. It raised the interest rates for the first time in nearly a decade by a quarter percentage points to 0.25-.50%, citing that U.S. economy has largely emerged from the impact of the financial crisis and the Great Recession.

The central bank further hinted at a gradual hike next year given the considerable improvement in the labor market and increase in inflation from undesirably low levels.

A Reason to Worry?

Higher rates would attract more capital to the country, thereby boosting the U.S. dollar against the basket of other currencies. This would have a huge impact on commodity-linked investments, reflecting that a rising rate environment will hurt a number of segments. In particular, high dividend paying sectors such as utilities and real estate would be the worst hit given their higher sensitivity to rising interest rates (read: Fed Rate Hike Wait May End Today: ETFs to Gain & Lose ).

Additionally, securities in capital-intensive sectors like telecom would also be impacted by higher rates. Higher rates would also result in tighter lending conditions and curtail consumer spending on a wide range of products like cars and houses. This will in turn hurt profitability across various segments.

Coming to the impact of higher rates on the fixed income world, as the rates rise, yields will also move higher hurting bond investments. All these are expected to result in higher market volatility, as the Fed will remain on track to raise rates albeit at a slower pace.

However, the initial phase of increase might actually be good for stocks, as it will reflect an improving economy and a lower risk of deflation. In particular, stocks that are rich in value characteristics with healthy balance sheets, high return on capital, low volatility, elevated margins, and track record of stable or rising sales and earnings growth tend to outperform in the rising rate environment (read: 5 ETF Outperformers with 20% Plus Gains Year to Date ).

As per the Goldman, quality stocks have a history of outperformance in the three months after an initial rate hike. Looking at data from rate-increase cycles that began in 1994, 1999 and 2004, companies with stronger balance sheets, high return on capital, and low volatility outperformed by 5%, 4% and 3%, respectively. Given this, we have highlighted three solid picks each from the ETF and stock worlds targeting this niche strategy for investors seeking to capitalize quickly on the initial phase of rates hike.

ETFs to Buy

MSCI USA Quality Factor ETF ( QUAL )

This fund provides exposure to the stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth, and low financial leverage) by tracking the MSCI USA Quality Index. In total, the fund holds 125 securities in its basket, which are pretty spread across a number of securities with each holding less than 4.8% of assets. From a sector look, information technology takes the top spot at 20.9%, followed by financials (16.4%), healthcare (14.8%) and consumer discretionary (14.0%). The product has amassed $1.8 billion in its asset base and charges just 15 bps in annual fees from investors. Average trading volume is good at around 160,000 shares per day (read: U.S. Quality ETF (QUAL) Hits New 52-Week High ).

PowerShares S&P 500 High Quality ETF ( SPHQ )

This fund tracks the S&P 500 High Quality Rankings Index, a benchmark of S&P 500 stocks that have solid long-term growth as well as stable earnings and dividend. This approach has resulted in a basket of 132 stocks with none holding more than 1.51% of total assets. The fund is skewed toward industrials at 26.7% while consumer discretionary and consumer staples round off the next two spots. The product has managed $587.7 million in AUM and trades in good volume of 124,000 shares per day on average. Expense ratio came in at 0.29%.

SPDR MSCI USA Quality Mix ETF ( QUS )

This fund offers exposure to stocks that have a combination of value, low volatility and quality factor strategies. This is done by tracking the MSCI USA Quality Mix A-Series Index. The product holds a large basket of 617 stocks, which are highly diversified across each component as none holds more than 2.58% of assets. Information technology takes the top spot from a sector look while financials, healthcare, consumer discretionary and consumer staples also receives double-digit exposure each. The fund has accumulated $5.9 million in AUM since its debut eight months ago. It charges 15 bps in fees per year from investors and trades in a paltry average daily volume of around 1,000 shares (read: 5 High Quality ETFs for an Uncertain Market ).

Stocks to Buy

To find out the best stocks in this space, we have used our Zacks stock screener . The parameters include Zacks Rank #1 (Strong Buy) or 2 (Buy), ROE of at least 10%, debt-to-equity ratio of less than 1, historically positive 5-year EPS growth, positive current-year EPS growth, positive current-year earnings estimate revisions over the past 30 days, and dividend yield of greater than 1%.

Foot Locker Inc. ( FL )

Based in New York, Foot Locker is a leading global retailer of athletically inspired shoes and apparel.

Zacks Stock Rank: #2

ROE: 23.11%

Debt/Equity: 0.05

5 Year Historical EPS Growth: 27.58%

Fiscal Year Earnings Growth: 18.96%

Positive Earnings Estimate Revisions Over 30 Days: 1.21%

Dividend Yield: 1.57%

Hormel Foods Corporation ( HRL )

Based in Austin, Minnesota, Hormel Foods is a multinational manufacturer and marketer of high-quality, brand-name food and meat products worldwide.

Zacks Stock Rank: #2

ROE: 18.56%

Debt/Equity: 0.06

5 Year Historical EPS Growth: 10.06%

Fiscal Year Earnings Growth: 10.46%

Positive Earnings Estimate Revisions Over 30 Days: 3.84%

Dividend Yield: 1.28%

Gentex Corp. ( GNTX )

Based in Zeeland, Michigan, Gentex is a manufacturer and supplier of automotive automatic-dimming rearview mirrors, automotive electronics, dimmable aircraft windows, and fire protection products.

Zacks Stock Rank: #2

ROE: 18.60%

Debt/Equity: 0.14

5 Year Historical EPS Growth: 18.22%

Fiscal Year Earnings Growth: 6.63%

Positive Earnings Estimate Revisions Over 30 Days: 0.12%

Dividend Yield: 2.15%

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days . Click to get this free report >>

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

ISHARS-MS US QF (QUAL): ETF Research Reports

PWRSH-SP5 HQ (SPHQ): ETF Research Reports

SPDR-MSCI US QM (QUS): ETF Research Reports

FOOT LOCKER INC (FL): Free Stock Analysis Report

HORMEL FOODS CP (HRL): Free Stock Analysis Report

GENTEX CORP (GNTX): Free Stock Analysis Report

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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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