Interest rates rise and fall as the economy moves through periods of growth and stagnation. The Federal Reserve is an important driver for rates, as officials often lower rates when economic growth slows and then raise rates to cool the economy when inflation becomes a concern.
Increasing rates require careful attention when crafting an investment portfolio. For example (and depending on the overall economic environment), an investor may bolster positions in short-term and medium-term bonds (which are less sensitive to climbing rates) or implement a bond ladder to maximize cash and debt returns.
An environment where interest rates rise amid signs of an improving economy can also offer opportunities for equity investors. To find such opportunities, it can be helpful to examine the sectors within the stock market that tend to benefit from higher rates in a healthy economy.
Key Takeaways
- Some sectors within the stock market are more sensitive to changes in interest rates compared to others.
- Financials benefit from higher rates through increased profit margins.
- Brokerages often see an uptick in trading activity when the economy improves and in higher interest income from higher interest rates.
- Industrials, consumer names, and retailers can also outperform when the economy improves and interest rates move higher.
- Some sectors, such as real estate, can cool down during interest rate hikes.
The Interest Rate Environment
The COVID-19 pandemic had a pronounced, depressive effect on global financial markets. But it wasn't just the public that was worried. The deep uncertainty about economic activity led to the Federal Reserve slashing the federal funds rate to a range of 0% to 0.25%. It stayed at these levels until March 2022 when the Fed realized it needed to raise rates to combat rampant inflation.
Fed Chair Jerome Powell made the announcement on March 16, 2022. This was the first increase in the federal funds rate since 2018. Many economists believed the Fed would increase rates further to combat inflation, which was above the target of 2%.
Raising interest rates leads to higher borrowing costs, which can lead to a slowdown of growth, which in turn helps to control inflation.
Stocks to Watch When Rates Rise
You should always bear in mind the current state of the economy when you're creating or making changes to your portfolio. This includes when the economy is improving and is healthy, or when it's overheated or inflationary.
In any case, there are certain stocks you may want to look at when interest rates rise, including:
| Company | Ticker | Industry |
| Bank of America | BAC | Financial (Banking) |
| JPMorgan Chase | JPM | Financial (Banking) |
| Goldman Sachs | GS | Financial (Investment Banking/Brokerages) |
| Citigroup | C | Financial (Banking) |
| Charles Schwab | SCHW | Financial (Investment Banking/Brokerages) |
| Allstate | ALL | Insurance |
| AmTrust Financial Services | AFSIN | Insurance |
| The Travelers Companies | TRV | Insurance |
| Whirlpool | WHR | Electronics/Appliances |
| Kohl's | KSS | Retail (Department Stores) |
| Costco Wholesale | COST | Retail (Specialty Stores) |
| Home Depot | HD | Retail (Home Improvement) |
| Ingersoll-Rand | IR | Industrial (Machinery) |
| PACCAR | PCAR | Industrial (Trucking/Construction/Machinery) |
Why do these companies perform well when interest rates increase? It all boils down to their industries.
Financials First
The financial sector has historically been among the most sensitive to changes in interest rates. With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates. Central bank monetary policies and the Fed's reserver ratio requirements also impact banking sector performance.
Banks
Rising rates can point to a strong economy. That usually means that borrowers have an easier time making loan payments and banks have fewer non-performing assets. It also means that banks can earn more from the spread between what they pay to savers for savings accounts and certificates of deposit (CDs) and what they can earn from highly-rated debt like Treasuries.
Banks that might benefit as rates rise include:
- Bank of America, which has a substantial presence throughout the U.S.
- JPMorgan Chase with its robust operations in the U.S. and worldwide
- Goldman Sachs Group with widespread investment banking and wealth management services
- Citigroup, which does business in more than 160 countries
Brokers
On the broker front, companies like Charles Schwab and Goldman Sachs (which is also part of the banking group) hold promise during times of escalating rates for similar reasons. A healthy economy sees more investment activity and brokerage firms may also benefit from increased interest income when rates move higher.
Insurers
Insurance stocks can flourish as rates rise. In fact, the relationship between interest rates and insurance companies is linear, meaning the higher the rate, the greater the growth. These same insurance providers, such as Allstate, AmTrust Financial, and Travelers don’t fare as well in low-rate climates because their underlying bond investments yield weak returns.
Insurers with steady cash flows are compelled to hold lots of safe debt to back the insurance policies they write. In addition, the economic health dividend also applies to insurers. Improving consumer sentiment means more car purchasing and improving home sales, which means more policy writing.
Beyond Financials
Financials aren’t the only potential star performers in a healthy rising rate environment. Consumer discretionary stocks also can see a bump because improving employment, coupled with a healthier housing market, makes consumers more likely to splurge on purchases outside of the realm of consumer staples (food, beverages, and hygiene goods).
Manufacturers and sellers of kitchen appliances, cars, clothes, hotels, restaurants, and movies also benefit from the economic health dividend. Companies to keep an eye on during interest rate increases include appliance maker Whirlpool Corp. and retailers Kohl's Corp., Costco Wholesale Corp., and Home Depot, Inc.
Finally, the industrials sector also benefits from the economic health dividend that can be indicated by rising rates. Companies like Ingersoll-Rand PLCand manufacturers of heating, ventilation, and air conditioning systems, tend to outperform, as well as companies like PACCAR, a maker of heavy-duty trucks and truck parts. Such companies can be among the first to benefit from any increase in housing starts.
Have Interest Rates Risen Since the COVID-19 Pandemic?
Rate hikes began to rise in 2022. On March 16, 2022, the Fed announced it raised its target for the federal funds rate to a range of 0.25% to 0.50%. This was the first time that the Fed hiked the rate since 2018. Since then, however, the Fed has raised the Fed funds rate beyond that as it combats inflation. As of July 2023, the Fed's target range was 5.25% to 5.5%.
What Are the Best Stocks to Buy When Interest Rates Are Set to Rise?
There are two different schools of thought when considering which stocks to buy before a rise in interest rates. Those who want to take advantage of the environment could consider stocks in the relevant sectors listed in this article. Alternatively, investors could set themselves up in a defensive position. In this case, they could invest in consumer staples, healthcare, and possibly physical assets like gold and precious metals ETFs.
Is the Financial Sector the Best to Buy When Rates Are Rising?
Financials tend to perform strongly in a rising interest rate environment (depending on the health of the overall market). Investors could see solid returns in defensive sectors as investors look to allocate their gains in sectors that are generally considered stable during market downturns.
The Bottom Line
You've adjusted your fixed-income portfolio to account for rising rates. In a strengthening economic environment, also consider adjusting your equity investments to favor companies that may benefit from accompanying rising rates. Again, an excellent place to start is the financial sector. From there, as consumer confidence picks up and housing follows suit, consider manufacturers of durable goods, retailers, travel-related stocks, and the industrials sector.
Article Sources
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Federal Reserve System. "How Does the Federal Reserve Affect Inflation and Employment?"
Citigroup. "About Citi Latin America."
Board of Governors of the Federal Reserve System. "Federal Reserve issues FOMC statement."
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