What are we looking for?
U.S. companies in interest-rate sensitive sectors.
The screen
Historically, when interest rates rise, stock pickers tend to gravitate toward interest-rate sensitive sectors such as financials (which benefit from lending at higher rates), consumer cyclicals (which benefit from increased consumer spending due to improving economic conditions) and industrials (which benefit from increase in production demand). In addition, companies with lower levels of debt will fare better since they are less affected by the rise in lending rates. This week, I look specifically at these three sectors and rank stocks based on the following factors:
- yield;
- cash flow to debt;
- industry-relative debt to equity (compares a company’s debt to equity with the median debt-to-equity ratio for the industry to which it belongs. Lower ratios are desired);
- forward P/E;
- three-month estimate revisions.
Qualifying stocks had a market cap of $6-billion (U.S.) or more, and a dividend payout ratio of less than 80 per cent. Only financials, consumer cyclicals and industrial stocks as defined by Morningstar's classification structure were included in the screen.
More about Morningstar
Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used CPMS to back-test this strategy from December, 1993, to May, 2015. During this process, 15 stocks were purchased and equally weighted with a maximum of seven stocks a sector. Stocks would be sold if they fell outside the top 50 per cent of the ranked universe. Over this period, the resulting strategy produced an annualized total return of 12.4 per cent while the S&P 500 total return index gained 9.4 per cent.
I also ran the back-test from January, 2004, to June, 2007 (a time frame when the U.S. federal funds rate saw a steady increases just prior to the 2008 crash), using the same assumptions. During this period, the strategy had an annualized total return of 17.8 per cent, while the S&P 500 total return index rose 10.7 per cent. The top 15 stocks that qualify today are listed in the table.
As always, investors are advised to conduct their own independent research before purchasing stocks shown.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.