Finance How to seize the opportunity of rising rates Rising interest rates aren’t all bad news. Far from it. For a select group of market sectors, rising interest rates can be very good for business. Once your portfolio is protected, you may want to take a look at some of the ideas below. Keep in mind that the following comments are general in nature – it’s up to you (and your advisor) to do your homework, and find specific securities that fit your personal risk tolerance within these overall themes. Change is coming... The Federal Reserve has given investors a great gift – advance warning of a change. Those who ignore the coming change do so at their own peril. While there’s no way to tell how quickly rates will rise in the U.S. (or for how long), or how that rise will affect interest rates in Canada, one thing is certain: they will rise, and the investment environment will change because of it. However, by no means are rising rates the end of the (financial) world. But they do require careful attention, and some thought as to what impact they’ll have on your personal circumstances. Over the next fewmonths, make sure to spend some time thinking about how you can protect yourself from rising rates – and seize any opportunities that may present themselves, too. Then, speak to your financial professional about any adjustments which you may need to make to your portfolio. Financials Perhaps the most obvious beneficiary of rising interest rates are businesses that make money from lending money, namely, banks. The higher the “spread” between the interest which they charge borrowers and the interest that they pay out on deposits, the more profit flows to the banks’ bottom line. Remember that most of the time, rates rise because the economy is improving. When the economy grows, businesses borrow to expand. Consumers buy more houses. Both businesses and consumers find it easier to repay their loans. All of this is extremely good news for those in the business of lending money. Banks aren’t the only financial companies that benefit from rising rates. Rising rates help insurance companies earn more money on their “float” – the money which they take in as policy premiums before paying it out as settlements. Asset managers (brokerage firms, mutual fund companies, etc.) can also see increased profits from rising-rate environments because rising rates often go hand in hand with periods of market strength and rising investor confidence. Industrials and consumer discretionary stocks These sectors are cyclical – their performance tends to wax and wane in line with the health of the overall economy. Historically, stocks in these sectors have shown a strong correlation to interest rates, making them good choices in times such as these. The reason is pretty simple: these kinds of businesses tend to sell more products when consumers feel confident in making a purchase. Unlike, say, toothpaste or allergy medication (which consumers need nomatter what the overall economy is doing), many people can put off purchases such as cars, appliances or new homes until they feel more confident about their finances. The same goes for industrial businesses selling new equipment to other businesses. If you believe in the underlying story of economic growth in the U.S., then it makes sense that such economically sensitive sectors stand to benefit in the months to come. Small-caps (especially U.S. small-caps) Most small-cap stocks (generally stocks with a market capitalization anywhere between $300 million and $2 billion) are businesses that are focused primarily on domestic markets – this is particularly true of U.S. small-caps. Such businesses are most likely to benefit from a strengthening U.S. economy, which is typically the backdrop for rising interest rates. Keep in mind that such stocks can be considerably more volatile than larger companies. If you’re interested in investing in them, it makes sense to do your homework, or hire a professional manager (via a small-cap mutual fund or ETF) to do it for you. Even then, you’ll want to limit your smallcap exposure to a small portion of your portfolio – say, between 10% and 15%, depending on your risk tolerance. Technology Another sector which typically benefits during times of rising interest rates is technology, particularly the larger, more mature technology stocks. The main reason is that technology is generally considered to be tied to overall economic growth. When businesses are expanding, they buy more of the “tools” which they need to help them grow and these days, technology is one of those tools. Conversely, when those businesses aren’t expanding, they tend to cut back their IT budgets and make do with what they have. Another reason is because many software, technology and computer equipment businesses don’t necessarily require large capital infusions in order to expand. In fact, most mature high-tech companies hold very little debt at all, making them somewhat immune to the higher interest rates that can sometimes drive heavily indebted companies under water (see above). Even better, higher interest rates mean that they can earnmore money on the billions in cash which they hold in reserve (as companies such as Apple, Microsoft, Cisco, Google/Alphabet and Oracle typically do). Unless you’re a veteran stock-picker, the best way to invest in technology stocks is through a diversified mutual fund or ETF portfolio. Such an investment is an easy and affordable way to invest in several sub-sectors of the broader technology industry (Internet companies; software; IT services; hardware & storage; semiconductors; etc.), while allowing you to spread risk and minimize volatility. CSANews | SPRING 2017 | 31
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