Are There Stocks That Benefit from Rising Interest Rates?
In 2022, central banks around the world hiked interest rates rapidly in order to tame surging inflation. This seems to be bearing fruit, as inflation shows signs of having peaked in many economies. However, whilst inflation may be moving in the right direction, we can expect interest rates to remain elevated throughout 2023.
So, how will this affect your investment decisions? What is the relationship between rising interest rates and stocks? Are there any stocks that benefit from rising interest rates? In this article, we will address these questions and others!
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Are High Interest Rates Good for Stocks?
Generally speaking, interest rates and stocks tend to have an inverse relationship. In other words, when interest rates rise, many share prices tend to fall.
However, the relationship is not that straightforward, and it is not always the case that stocks will react negatively towards higher interest rates.
Why Are High Interest Rates Bad for Stocks
To understand why rising interest rates can have a negative impact on stocks, we need to look at what the knock-on implications of higher interest rates are for businesses.
Higher interest rates increase the cost of borrowing and servicing existing debt, which increases operating costs, reducing profitability. The consequences of less profitability and a higher cost of new borrowing is less investment in future growth.
Moreover, the effects of higher interest rates are not just felt by businesses, but also consumers. As debt becomes more expensive to service, consumers’ discretionary incomes fall, leaving them less money to spend, which will also have a negative impact on company profits.
When a company’s profitability and future growth prospects fall, its estimated future cash flow also falls, which tends to weigh on share price.
Sectors That Benefit from Rising Interest Rates
Nevertheless, as noted earlier, the relationship between interest rates and stocks is not quite so straightforward, with some industries actually standing to benefit from high interest rate environments.
So, which sectors can benefit from rising interest rates? There are several which stand to benefit, below we will look at two examples.
Probably the most obvious choice for sectors that benefit from rising interest rates is the banking sector.
When interest rates are rising, banks can generate more income from their lending operations. Moreover, due to the fact that banks also pay more interest on customer deposits, deposits tend to increase, providing the bank with more capital for more lending.
Additionally, the higher interest rates are, the higher the potential difference in the interest rates that banks pay to savers and that which they charge borrowers. The effect provides an opportunity for higher margins in the banks’ lending operations.
However, there are also some potential risks for banks to consider. As the cost of borrowing increases, people become less inclined to take out loans, leading to a fall in demand for new debt. Furthermore, as the cost of servicing existing debt increases, the number of borrowers defaulting on payments can also increase.
Insurance is considered a defensive sector, meaning that it tends to performs well in all stages of the economic cycle. The reason for this is fairly intuitive, if people need insurance they will tend to find the money to pay for it, regardless of the economic environment.
However, insurance is also an example of an industry which directly benefits from higher interest rates, in the form of higher earnings.
Insurance companies generate a lot of cash from premiums and, in order to back their policies, are obliged to hold a large percentage of this cash in “safe” debt. In a high interest rate environment, this safe debt starts to generate more income.
Naturally, deposits in the bank will benefit from higher interest payments, but another thing to consider are bonds. Bond yields - which measure a bond’s coupon, or interest, payment as a percentage of its price – are positively correlated with interest rates. In other words, when interest rates rise, bond yields tend to rise as well, meaning that investors stand to make a larger return from investing in bonds.
However, the reason bond yields rise in tandem with interest rates is that interest rates cause bond prices to fall. When interest rates rise quickly, as they did last year, existing bond holdings lose some of their principal value, which can offset the benefit of higher yields for insurance companies.
Stocks That Benefit from Rising Interest Rates
So, now we know a couple of industries which stand to benefit, what about some specific stocks? Interest rates have remained at very low levels for more than a decade, as we enter a new era of higher rates, let’s look at some of the companies which could benefit from this.
Nevertheless, it is important to bear in mind that, whilst the stocks we will look at stand to benefit from higher interest rates for the reasons listed above, it does not necessarily mean that they will perform strongly in the coming months. Investing is never quite so easy, and there are many other factors to consider, not least of all the health of the economy.
Bank of America Corp.
The benefits of higher interest rates were plain to see in Bank of America’s fourth quarter results in 2022.
Despite a slump in investment banking fees and noninterest income dropping by 8% in 2022, net interest income soared 22% as Bank of America reaped the benefits of higher rates.
JP Morgan Chase
JP Morgan Chase (JPM) is the largest bank in the world by market capitalisation and, like Bank of America, it saw some of the benefits of higher interest rates in 2022.
In JPM’s Q4 results, whilst noninterest revenue slipped 8% year on year, net interest income soared 48%.
MetLife is one of the largest insurance providers in the world, serving approximately 100 million customers in almost 50 different countries.
Although net investment income fell in the fourth quarter of 2022 and in the full-year, MetLife stands to potentially benefit from higher interest rates as it can put its cash to work in higher-interest earning assets.
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