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Rising Interest Rates: It's Not All Bad

14 June 2013 in Trading Ideas

With the 10-year Treasury note yield now at 14-month highs, many investors seem to be in two camps: those who believe it portends bad things and those that aren’t yet finding reason to fret.

What anybody’s perceived impact of higher rates is seems to depend on one’s take on both the health of equities and the overall economy. Zane Brown, fixed-income strategist for Lord Abbett, takes the sanguine view. He told CNBC.com that he doesn’t expect rates to increase much more from here, and he said he believes many more investors have begun ignoring comments from the Federal Reserve that it needs to see self-sustaining economic growth before it begins tapering its actions to keep rates low.1

 

What’s more, Brown believes it’s likely the Fed will do – or say – something to stop the rise in yields if it continues, possibly as early as the Federal Open Market Committee (“FOMC”) meeting next week.

For now, Brown said the selling in fixed-income is overdone, and that equities still look favorable, especially if investors expect the economy to improve.

Contrast those beliefs with those of Barry Knapp, head of US equity portfolio strategy at Barclay’s, who declared in the same article that the relentless rise in rates is “clearly negative news” for equities. He contends that we’re “well beyond” the benign 30-basis-point increase in rates.

Knapp says that if history is any guide, interest-rate-sensitive stocks will sell off, which, he says, has happened, followed by a selloff in cyclical stocks. If the Fed moves to pare back easing and the economy isn’t improving, Knapp adds, earnings won’t improve. “You’re sort of in a lose-lose in terms of buying the cyclicals,” Knapp said.

However, rising interest rates are certainly not negative for all stocks – that’s the investment thesis behind the Rising Interest Rates motif, a portfolio of 10 stocks that could find favor in an environment where rates continue to rise. The companies represent sectors such as custodian banks, brokerage firms, and payroll processors that generate cash flows by charging interest on customer assets they hold.

It’s worth noting that since the beginning of May, when the 10-year Treasury yield rose from less than 1.7% to its current level of 2.2%, the Rising Interest Rate motif has increased 10.2%. It’s up 21.1% so far in 2013, and has climbed 40.6% in the past 12 months.

For investors, the trick may be deciding at what point the impact of higher interest rates may pose bigger risks for the companies that have been thriving on the upturn.

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1Patti Domm, “Rising Rates Have the Attention of the Stock Market,” CNBC.com, June 10, 2013, http://www.cnbc.com/id/100804680.

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