WHEN RATES RISE, CONSIDER THESE TWO SECTORS
The Federal Reserve decided not to increase interest rates last week, attributing their decision on the US economic activity expanding at a moderate pace and better economic data. But many traders and analysts believe the US central bank remains on course to increase rates later this year. For them, the Fed will likely raise rates gradually.
Should the central bank hike rates, several financial assets such as stocks will be affected as higher short-term rates will stream through the markets. Speaking of stocks, we have seen two prospective opportunities in the technology and financials sectors. The two industries are cyclical sectors, meaning they tend to rise when the economy is strong.
According to Forbes, technology companies own around 40% of the overall corporate cash reserves in the United States, making them less vulnerable to escalating rates than debt-laden companies. The sector has the potential to carry on with their shareholder-favored policies such as share buybacks, M&A activity, and dividend increases. Also, its valuations have escalated in recent months. Tech companies, as gauged by the S&P 500 Information Technology Index, traded with a 6% price-to-earnings (P/E) discount to the S&P 500 as of last month.
Higher rates are tantamount to higher revenues for some financial institutions, including banks. There will be a huge difference between what banks earn and their costs for deposits. It may increase. Also, they have started reorganizing their balance sheets toward variable rate loans, so they won’t be enclosed into low rates and they are hedging their rate exposure.
Financials in the country shined the most in the second quarter. Looking at their earnings, 60% of them surpassed revenue projections, way above the overall sector average. Financials also represent a relative bargain, unlike other industries. Not to mention the financial sector is still considered one of the cheapest sectors both in terms of price-to-earnings and price-to-book ratios. Its P/B is just half of the entire American market.