8 Winners and Losers in a Rising Interest Rate Environment
If the shocking defeat of Obamacare repeal and reform proved anything, it's this: Sometimes, a Magic 8-Ball works better at predicting major outcomes in the nation's capital than, say, a pragmatic pundit. And so it goes with interest rate hikes and the Federal Reserve: Will they? Won't they?
No matter the chances of correctly calling an interest rate increase – and an overwhelming number of observers see more of those coming in 2017 – certain industries and sectors stand to benefit, while others will suffer. Here is a look at eight sectors and investments that could win or lose as rates rise.
Winner: Domestic Banks
Higher interest rates mean more money made on loans and credit cards, but there are other reasons banks should do well no matter what the Fed does.
[See: The Best Energy Stocks to Buy for 2017.]
"Unlike most of the other companies in the S&P 500, they have little or no revenue from outside the U.S.," says Ellen Hazen, senior vice president and portfolio manager at F.L.Putnam Investment Management Co. in Wellesley, Massachusetts. "They benefit from the higher interest rates that are ultimately driving the stronger U.S. dollar without suffering from lower income."
Loser: Debt-Intensive Industries
This rule of thumb applies as rates creep up: "Lenders and savers are winners and borrowers are losers in the broadest sense," says Will Kenton, senior news and markets editor at Investopedia.
One investment tactic is to look at the companies that take on a lot of debt to finance their growing and operations.
Says Kenton: "Capital and debt-intensive industries such as telecoms, manufacturing, shipping and construction will suffer."
3 Takeaways from the March Rate Hike
A quick rundown of the major takeaways from the Fed's most recent rate hike.
John DivineMarch 16, 2017
<p> Federal Reserve Chair Janet Yellen addresses the Executives' Club of Chicago, Friday, March 3, 2017, in Chicago. Yellen signaled that the Fed will likely resume raising interest rates later this month to reflect a strengthening job market and inflation edging toward the central bank's 2 percent target rate. (AP Photo/Charles Rex Arbogast) </p>
As co-author of "The Association Between Federal Reserve Policy and Sector Returns," Bob Johnson notes that energy is among the best performers when interest rates move up – finishing ahead of other winners such as consumer goods, utilities and food.
They all have this in common, though.
"People need to eat, brush their teeth and heat their homes whether the economy is strong or weak," says Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pennsylvania.
Loser: Home Construction
The higher mortgage rates that follow the Fed's actions put a damper on real estate activity, says James Cassel, chairman and co-founder of the investment banking firm Cassel Salpeter in Miami.
If that happens, losers might include "construction-related businesses, like homebuilders," he says.
But with mortgage rates still at historic lows, "I do believe there's still some ways to go with additional rate increases before we see a material effect," Cassel adds.
Winner: Home Improvement
When interest hikes compel would-be homebuyers to hunker down, they take on home improvement as a consolation prize – a good thing for Lowe's Cos. (ticker: L) and Home Depot (HD).
"Remodelers and home-improvement suppliers benefit from a rising-rate scenario," says Sesha Dhanyamraju, CEO of Digital Risk, a provider of outsourced mortgage processing services.
[See: 7 of the Worst Product Flops Ever, Besides the Samsung Galaxy Note 7.]
"Homeowners with a low mortgage rate are far more likely to stay in their homes and spend to improve them than pursue a new house ... with a higher mortgage rate" Dhanyamraju says.
No matter how much some consumers may grumble, rising interest rates mean good news on at least one front.
"The technology sector should benefit as rising interest rates usually correlates with an economy that is getting stronger and is expected to grow at a faster pace," says Ronen Schwartzman, founder and chief investment officer of Ten Capital Advisors in New York City.
And a strong economy could bolster the bottom lines of smartphone manufacturers such as Apple (AAPL) and Samsung.
A Rate Hike Won't Matter Much to You
Markets will be looking for signs about what the Federal Reserve intends to do next.
Kira BrechtMarch 14, 2017
Federal Reserve Building
Loser: Government Bonds
If rates rise again soon, there could be some vulnerability for investors overexposed to certain types of bonds.
"A slight increase in rates would erase the coupon return for intermediate and long-term government bonds," says Daniel Kern, chief investment officer of TFC Financial Management in Boston. "Investors concerned about potential rate hikes may want to emphasize shorter-term government bonds until rates stabilize."
Meanwhile, "Dividend-paying stocks offer the appeal of income and growth," Kern says.
Eric Ervin, CEO of Reality Shares, a research firm and exchange-traded-fund provider focused on dividend-growth investing, believes that telecoms, because of their high yields, "will most likely suffer the most when with rising rates."
Yet while this sector is sensitive to interest rate hikes, it isn't necessarily vulnerable. In large part, any potential hurt depends on how much rates rise.
So far, so good: Over the last year, AT&T (T) is up nearly 7 percent – and 13 percent since Election Day, trading at about $24 per share.
The Best And Worst Sectors For Rising Interest Rates
Industries Most Affected
The graph below shows some of the industries that have unusually extreme LTB betas, either positive or negative.
Source: Graph created by author using data from FactSet
Those on the left side could be described as economic recovery industries. They typically suffered poor returns in 2020 and are only recently seeing their stock prices recover. They are also most often considered value industries as opposed to growth industries.
The industries on the right side are a varied lot. Some are clearly associated with the “winners” in 2020, especially software, medical equipment, and solar. These are all growth industries in which a large portion of the expected cash flows are many years down the road. Consequently, they have been hurt by rising rates through the mechanism of the increased discount rate.
Other industries on the right side are sensitive to changes in interest rates through the economics of how their businesses operate. For example, the demand for real estate and home construction is strongly influenced by mortgage interest rates—when rates move up, demand falls. Similarly, gold miners are affected by the price of gold, which in turn is affected by interest rates because gold does not provide any interest or dividend income, and when interest rates rise, the opportunity cost of owning gold increases, making it a less attractive store of value.
This week the DOW broke out to all time new highs in a perfect wave location: Int. iii of Major 3 of Primary III, or 3 of 3 of 3. For comparison purposes we took a look at the last ‘breakout to all time highs’ in 2006. We then adjusted the wave count of that bull market as if it too were a Cycle wave. Under that wave count the previous ‘breakout’ was also at Int. iii of Major 3 of Primary III. A perfect fit, but there is more.
During the 2002-2007 bull market it took exactly 48 months of bull market activity before the breakout occurred. Then the market topped exactly 12 months later. That bull market began in Oct02, broke out in Oct06, and topped in Oct07. This 2009-2013 bull market has also taken exactly 48 months before the ‘breakout’. The bull began in Mar09, broke out Mar13, which now suggests a bull market top in Mar14.
Following this theme: breakout to new highs – then top within twelve months. We checked further back into market history and noticed the following. After the 1998 crisis the DOW made new all time highs in Jan99, then topped in Jan00. After the 1987 crash the DOW made new all time highs in Aug89, then topped in July90. There is definitely a time/price pattern at work here.
Adding to this probability is the potential for an upcoming recession, using the irregular presidental recession cycle. Since 1949 there have been eleven recessions. Three occurred in an election year, at the end of a president’s term. But eight occurred within 18 months after a new/second term president was sworn in. President Obama was sworn in January 2013.
If we now make the assumption that the bull market high will occur in Feb/Mar14 to complete Cycle . This five year bull market will have matched, in time, the five year bull of the previous Cycle wave : 1932-1937. It will have also matched, in time, the previous bull market: 2002-2007. Then, however, the market enters a new treacherous bear market period: Cycle wave .
After the last Cycle  1932-1937, Cycle  dropped 49% in 12 months into 1938. Cycle  should have ended there with that percentage of decline. Cycle waves generate about a 50% market correction. After a big bullish looking rally into 1939, Germany invaded Poland and the market eventually went back to the 1938 lows by 1942. Cycle  should have lasted 1 year (12 months). This would have been similar to Cycle  which also lasted 1 year, 1973-1974 (21 months). The percentage of decline is important, not the time, as we recently observed in the 2 year, Oct07-Mar09, (17 month), 54% decline.
The next thing of interest is the presidential 4 year cycle, which typically bottoms in the months Mar/Jly/Oct. It has a pretty good record: 1982, 86, 90, 94, 98 and 2002. But occassionally it gets out of sync. In example: 2006, 2010, and soon 2014. When this occurs it eventually realigns, sometimes rather quickly. For example: 1946 made a high then a mini crash followed into the 4-year low, 1962 made a high and a mini crash followed, and 1990 made a high then a mini crash followed.
Finally, with about a 50% market loss expected for Cycle , the 4 year low potentially bottoming in 2014, and possibly a Secular cycle low as well. We looked back in market history for huge declines during a short period of time. We found two historical periods of huge declines, bonafide crashes, in just two months: 1929 -48%, and 1987 -35%. The 1929 crash, was a straight down one downtrend event. The 1987 crash was an unusual five wave/trend elongated flat event. Primary wave II, during this bull market, duplicated that pattern during its 19% decline. An omen of things to come?
With high frequency trading, long term rates heading higher, and the USD in a bull market. There is now the potential for a bull market high in Feb/Mar14, then a bonafide market crash during 2014. This is just another example of investor mass psychology patterns in action: past, present and future.
Harry Dent: Stock Market Roller Coasters and Bear Megaphones
Booms and busts in the economy are based on predictable demographic cycles such as those studied by Harry Dent, founder of HS Dent, chairman of SaveDaily.com and author of "The Great Crash Ahead: Strategies for a World Turned Upside Down." In this Gold Report interview, Dent predicts a global crash between mid-2013 and early 2015, in an ongoing decade of economic coma. For now, gold and gold equities are great investments, but when the crash comes, read on to find out what he suggests will be a good sector until the echo generation enters the workforce and starts buying potato chips and houses.
The Gold Report: Harry, you base your economic predictions largely on demographics and demographic cycles. As the baby boomers enter old age and spend less, will that quash any hope of an upward trend in the overall economy?
Harry Dent: Ultimately, yes. Spending by baby boomers hit its peak in countries like the U.S. in 2007. On average, baby boomers will spend less and less in the years ahead as they move toward retirement. Governments and central banks around the world keep stimulating to keep their economies up and to keep their banks from failing, but they are fighting against the largest generation in history. Stimulus works less well with an older population that does not have kids to raise and put through college. Demographics will make stimulus plans more and more difficult, and at some point they will fail.
TGR: A lot of your thinking is rooted in history. One of your recent articles mapped the trajectory of the 1929, 1968 and 2007 booms and busts, noting that politicians and investors blew those opportunities by focusing on the symptoms rather than the causes. Is there any tactic that can overcome the demographics?
HD: We have two major trends. The first is the baby boom peaking in most wealthy countries. The second is the greatest debt bubble in history, especially in real estate.
Private sector debt has grown 2.7 times the economy since 1983; government debt has grown almost as fast. In a debt bubble, assets rise, people overspend, businesses overexpand and it takes a period—usually a decade or so—to work off those excesses. Today, governments around the world are refusing to countenance a downturn. They are trying to replace every dollar of economic downturn or of bank losses with stimulus money created out of nowhere. Similar to an addict taking more and more of a drug to not come down off of a high, the governments are keeping the bubble going.
Stimulus can avert a crisis in the short term, but not long term. You have to deal with your debt or you will not emerge from the crisis, as Japan has shown clearly after 23 years of a coma economy.
TGR: One of the trends you wrote about recently was what you called the "currency war" among Japan, the U.S. and the Eurozone, in which all are printing money. What does that mean for investors and how should investors react?
HD: After the last great debt bubble, in the 1930s, governments did not step in to prevent the collapse of banks. Governments did increase trade tariffs, which led to trade wars.
Recently, Japan's strategy has been to print enough yen to push down its currency to increase exports, even though its domestic economy is dying due to an aging population, bad demographic trends and super-high debt ratios. By doing this, Japan is starting the next trade war. Other countries will respond by lowering their currencies and doing more stimulus. If you keep doing this, the whole thing will break down at some point.
The question is when. We think the next breakdown will start in late 2013 or early 2014.
Europe tried a $1.3 trillion quantitative easing (QE) stimulus program in late 2011/early 2012, but fell into a recession anyway. The U.S. has had QE3 and now, QE3 Plus. Japan, too. These are signs of desperation, not progress. Countries cannot reinvigorate economies that are comatose, they can only keep them barely alive on life support.
These latest stimulus plans will create very little incremental growth and even decline. Stimulus only works so long because it is artificial. It is not real.
TGR: Do you expect the result to be inflation or deflation?
HD: We had deflation for several months in late 2008 and early 2009, when the financial system actually melted down from the debt bubble bursting. Then the government stepped in and started stimulating like crazy to create inflation. If we had seen this level of money printing and stimulus anytime in the past, inflation would have gone through the roof. But it has not; inflation is at a modest level.
With governments fighting deflation with inflation, we will get more inflation in the near term from all the stimulus. But if the system melts down again, which we expect between late 2013 to early 2015, deflation will set back in. There is also likely to be another crisis and deflationary period between 2018 and 2019. These are the two danger periods we see ahead for investors.
The pattern is inflation, deflation, then another government stimulus plan, followed by minor inflation and then deflation again. Until governments eliminate their restructured debt, they cannot come out of their debt crises. No government is doing this, which is not a good sign for the future.
TGR: How can investors protect themselves in such an unsettled economy?
HD: Investors must realize that there is a new normal. Stocks will not be growing at 12%/year. Bonds will not yield 5–6%. The new normal is not even the expectation of 4% on stocks and 2% on bonds that people like Bill Gross from PIMCO suggest. The new normal is a roller coaster of one bubble bursting after another.
Investors have to get away from the traditional concepts of diversification and asset allocation for the next decade or so. When bubbles burst, everything goes down. In 2008, real estate, oil, commodities, gold and silver crashed. The U.S., European and emerging markets crashed.
With each bubble, the market has gone to a slightly new high and to a slightly new low when the bubble bursts. We call it a megaphone pattern.
We are likely to see new highs in a lot of stock indexes in the first half of 2013. Our target for the Dow is 6,000 in the next two or three years, when we see the next burst coming.
You need to think like a long-term trader. Get more defensive. When stocks crash, get back into them. This will not be a decade where investments will only go down. It will be a roller coaster of boom, bust, boom, bust.
TGR: Roller coasters can be scary things. Unless you are looking in the rearview mirror, how do you know when is the high and when is the low?
HD: It is not easy. We predict that the Dow could go as high as 15,000 this year before dropping to 6,000 in early 2015. Nobody can predict the exact top or the exact date.
You can only guess by seeing when investors are overly bullish or bearish and when patterns are stretching on. And if governments are able to contain the next crash and crisis to, say, 1,100 on the S&P 500, then we will see a bigger crisis between 2018 and 2019.
The megaphone pattern is the best single pattern we have right now. The next top in this megaphone pattern in the S&P 500 is around 1,600; only 6% from now. Stocks do not have a lot of upside despite all the good news about fiscal cliffs being averted, QE3 Plus and stimulus from Japan and China.
I do not see a lot of good news coming. Baby boomers will keep aging and spending less. Stock earnings are decelerating, although still growing for now.
Gold is the one thing we see going up more than anything else in the near term. The more money governments print, the better it is for gold. But when that government strategy fails and economies melt down, gold will go down.
Gold and silver may be the best investments in the next several months. The gold and bond bubbles will be the last to peak as even the bond bubble seems to be starting to unravel. Everybody has been rushing into gold, silver and bonds as safe havens, but the truth is investors keep rushing into every bubble until it bursts and, at some point, all the bubbles burst.
TGR: How high do you think gold could go before it bursts?
HD: For two years, gold has been trading between $1,520/ounce (oz) and $1,800/oz. If gold breaks above $1,800/oz, the next target is $1,934/oz (the past high), and then a new all-time high is likely between $2,030–2,080/oz. If it gets that high, we would advise people to take their gains in gold.
However, I think gold is likely to fall to $750/oz in the next two to three years, maybe even lower.
TGR: What about gold equities, particularly the juniors, are they on a downtrend or have they hit bottom and are ready to come back up?
HD: I think gold stocks are near a bottom and, like gold, are likely to rally in the first half of 2013. The equities are much oversold. Traders are very bearish on them, which is a good sign.
In general, we see stocks in the U.S. and Europe as having 4–6% on the upside. However, silver and gold stocks could go up anywhere from 10–25%. Gold and silver equities are very good plays right now.
TGR: You have called this an opportunity for once-in-a-lifetime investment success and have suggested investing in Asian, multinational, technology and healthcare stocks. What are some specific names that could succeed in this roller-coaster environment?
HD: I focus more on sectors than stock analysis. In general, whenever there is a crash, you want to buy because another bubble or expansion will follow, even in a long-term bear market. You want to buy the sectors most favored by technology and demographic trends.
If I am right, and stocks crash again in late 2014 or early 2015, I want to buy in the healthcare sector in the U.S. and Europe, especially the most leveraged areas: biotech, medical devices and pharmaceuticals. The baby boomers will continue spending on healthcare and healthcare products, even as budgets get crimped by entitlement reductions. [Editor's Note: For more ideas on investing in the life sciences, visit The Life Sciences Report].
Next, I want to invest in areas of the world with strong demographics and emerging countries that are not as dependent on commodity cycles. We think commodity cycles, which have peaked every 30 years, most recently between 2008 and 2011, will go down into the early 2020s before turning up again. Instead of emerging areas like Brazil, the Middle East or Africa, which are large commodity exporters, I want to invest in countries like Vietnam, Cambodia, Thailand, Indonesia and especially India. India is not a major commodity exporter and it has the best demographics.
But whatever you buy, you have to wait for the crash, maybe two to three years from now. You have to wait for the crash because all stocks go down to some degree in a crash, so you do not want to buy now.
TGR: Do you also trade based on the daily headlines? For example, I have read about Apple Inc. (AAPL:NASDAQ) taking a short-term dip that is part of a larger wave. Do you take advantage of daily dips?
HD: We are more expert in the long-term trends, demographics and cycles, but, yes, we do look at the short-term technical indicators. Stock being oversold or overbought or people being overly bullish or bearish are the most important factors.
Apple is a classic example. It was around $700/share and in a matter of months went down to $440/share. Wall Street loved Apple and now is shedding the stock. That is classic short-term thinking.
Apple will probably go a little lower, but it is undervalued now. I would rather buy Apple than Google Inc. (GOOG:NASDAQ). In fact, I would rather buy gold, which is undervalued and overly bearish.
Long-term trends are highly predictable. Short-term trends depend on political decisions like the fiscal cliff and on traders over- or undervaluing stocks.
TGR: We have talked about the baby boomers. Let's turn to the other end of the age spectrum. According to your research, when will enough young people be in the workforce earning money, buying potato chips and houses to pump up the economy again?
HD: We are looking for that to happen in the early 2020s. That is when the echo boom, the next generation, will enter the workforce in large enough numbers and start to raise their families and buy housing. The next boom will not be as strong, but it will turn the trends back up.
The echo boom generation in almost every wealthy country—whether it is in Japan, which peaked earlier than us, or Korea, which will peak later—is not as large as the baby boom generation. The baby boomers built all this housing and infrastructure, and it bubbled and now it is bursting.
Look at Japan. Real estate there has been down for two decades. The next generation should be buying houses by now, except the young generation has much more part-time work and lower wages than its parents' generation. The older generation has been protecting all of its benefits and entitlements and retiring at their expense. A recent survey showed that 40% of young Japanese males have no interest in sex, dating or marriage. Why? Because they cannot afford it. They just want to be carefree and survive on a small budget.
Everything that has happened in Japan will happen in Europe and the U.S. The U.S. and Northern Europe, where the echo generation will move forward in the early 2020s, have better demographic trends than Southern Europe, Germany and Switzerland. The trends in East Asia, Japan, Singapore and Korea and eventually China, are horrible.
TGR: What should we be doing while the market is in a coma to be ready to prosper when the country comes back in 10 years?
HD: Fortunes were made in the early 1930s, from Joseph Kennedy to major companies, like General Motors and General Electric. In a downturn, you take advantage of the fact that everything falls. Buy when things are down.
Everyone likes a sale. Who would not want to buy a $500 Brioni shirt for $150 or pay $30,000 for a Mercedes that normally goes for $60,000? That is what will happen in financial securities over the next decade.
We will continue to see crashes, and after a crash you can buy businesses, commodities, real estate, stocks, even gold, at unbelievably lower costs. You create wealth by buying things at the bottom.
The smart people in the new normal environment of ongoing crashes think like long-term traders. They sell stocks, commodities, real estate and gold when they are high and re-buy them at unbelievable discounts when they crash. The world is your oyster if you are patient.
Your key goal should be to protect the gains you made in the greatest global bubble boom in history. Get out, keep cash and wait for the next big crash. Then buy at $0.20 or $0.40 on the dollar. What could be better than that?
TGR: Sounds like an opportunity to me. Thanks, Harry, for your time and your insights.
Harry S. Dent Jr. is founder of HS Dent, an economic research firm; editor of Survive and Prosper newsletter; and chairman of SaveDaily.com, a low cost investment platform for financial institutions. His mission is "Helping People Understand Change." Using years of hands-on business experience, in the late 1980s Dent developed a new way of understanding the economy and forecasting what lies ahead based on consumer demographics, which he outlined, in late 1992, in his book, "The Great Boom Ahead." In that book he stood virtually alone in accurately forecasting the unanticipated boom of the 1990s and even called for the next great depression to start in 2008. Dent has authored several bestsellers including "The Great Depression Ahead in 2008," and his latest, 2011 book "The Great Crash Ahead: Strategies for a World Turned Upside Down," he outlines why government stimulus is doomed to failure and the economic havoc that lies ahead. Dent regularly lends his economic expertise to the media on television, in print, and on the radio, and is sought after as a panelist and speaker for international forums around the world. He graduated from the University of South Carolina and earned his Master of Business Administration from Harvard Business School where he was a Baker Scholar. Subscribe to the free daily Survive & Prosper newsletter at www.harrydent.com.
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