Which Stocks Will Benefit From Higher Rates?

By David Bassanese | More Articles by David Bassanese

An emerging investment theme over the past few weeks has been a possible re-evaluation by central banks of their extra-ordinary monetary stimulus measures.

Indeed, the Federal Reserve now seems increasingly likely to recommence its interest rate tightening schedule in December, and the Bank of Japan is now trying to steepen Japan’s yield curve rather than simply pushing interest rates overall further into negative territory. There’s even rumours that the European Central Bank is preparing to backpedal on its aggressive policies also.

US 10-year Government bond yields have already lifted by around 20 basis in October so far, from around 1.55% to 1.75%., though there are still well below their 2.3% level at the start of 2016.

With the prospect of rising global bond yields over the coming year now a looming threat, it begs the question: which stocks might most benefit?

We already know which stocks will be most hurt. As has been already evident in recent weeks, even the modest move in bond yields to date has severely hurt so-called “bond proxies” of the equity market, such as telecommunications, utilities and listed property.

Of course, there’s a risk that equities markets overall could take a hit. Given price to earnings valuations remain at high levels, and earnings growth is still patchy, the prospect of higher bond yield may well lead to an overdue correction in overall equity prices over the next few months.

To my mind, however, there are at least two areas of the market that might benefit from a rotation out of defensive yield plays in the coming year – at least in a relative sense.

The first are key global cyclical sectors, such as technology. Indeed, US tech giants have continued to display relatively good earnings growth and should continue to do well if the US economy keeps chugging along at a fast enough pace to justify further Fed rate hikes in 2017.

At around 18 times forward earnings, PE valuations for the Nasdaq-100 index are still somewhat below their long-run average of just over 20. Investors interested in the tech sector can gain exposure through an ASX traded exchange traded fund (ETF) that tracks the Nasdaq-100 Index (NDQ).

Another potential theme that could do well in an environment of rising global bonds yields is global banks. Indeed, global banks have been so beaten up in recent times (think Wells Fargo and Deutsche bank) that they’re potentially the contrarian trade idea of 2017.

Why might global banks do well? For starters, they appear relatively cheap – with price to book valuations well below those of Australian banks, and at a relatively high discount to that of global equities overall.

Note global banks tend to benefit from higher bond yields – and especially yield curve steepening – as it better enables them to make money from their usual “maturity transformation” role of borrowing short-term at cheap rates and lending longer-term at higher rates.

Indeed, one reason central banks appear to be re-thinking their extreme monetary measures is that low to negative interest rates seems be hurting rather than helping the ability of banks to lend and make money. That’s consistent with Federal Reserve research suggesting global banks tend to enjoy high net interest margins when the overall level of interest rates is higher.

Those interested in such a contrarian trade might consider the ASX traded Global banks ETF (BNKS). 

David Bassanese

About David Bassanese

David Bassanese is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR)

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