What are we looking for?
Stocks set to benefit from rising interest rates.
One week ago, despite growing concerns over a potential trade war, the Bank of Canada raised interest rates by 25 basis points. The U.S. Federal Reserve next meets on Aug. 1, when it will likely leave rates unchanged. However, Thomson Reuters calculates that the market-implied probability of a rate hike by the following meeting, on Sept. 26, is currently 88 per cent. Generally, higher rates are bad for equities. Borrowing to finance growth becomes more expensive and valuations are lowered – the rate at which future potential earnings are discounted, to reach a theoretical present value, increases.
Some company stocks, however, exhibit positive correlation to interest rates (generally financial companies who can profit from higher rates). To find these companies we ran a “multiple regression” on the stock of each company in the S&P 500 against both the overall S&P 500 and the two-year U.S. Treasury benchmark. Note that the overnight rate moves stepwise with the decision of central banks, whereas movement in the two-year Treasury is smoother and reflects expectations of future rate movements. (Including the S&P 500 in our regression model serves to isolate and essentially strip out the effect of the overall market from the statistical effect of interest rates.)
The interest-rate sensitivity column shows the coefficient of regression for this variable. In short, a positive number means the company benefits from increasing rates, and the higher the number the greater the benefit.
The screen
• First we look for companies whose stock should be a good investment regardless of interest-rate environment. We use the Thomson Reuters Combined Alpha Model, which considers momentum, valuations, buy-side sentiment, analyst sentiment, short interest, insider transactions and earnings quality. We screen the S&P 500 and require a score of 95, that is, the top 5 per cent.
• For the interest-rate sensitivity described above we require a value (or coefficient) of at least 0.10. The stocks are ranked by this metric.
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What we found
The third column shows the “business activity” as defined by the Thomson Reuters Business Classification Scheme. Not surprisingly, all of the companies are in the financial sector.
Citizens Financial Group Inc. has both the most positive exposure to rising rates as well as the highest Combined Alpha score. Citizens also just launched Citizens Access, a direct-to-consumer digital bank that allows customers to do all of their banking online. An account can be opened from a mobile phone in less than five minutes. Citizens Access is also providing clients with digital tools to create a certificate of deposit (CD) ladder, allowing them to benefit from higher, longer-term rates without having to lock up all of their money at the outset – an offering that could be increasingly popular if rates do, in fact, rise.
Investors are encouraged to do their own research before investing in any of the stocks shown here.
Hugh Smith, CFA, MBA, works in the financial and risk unit of Thomson Reuters and specializes in wealth and asset management.
Hugh Smith, CFA, MBA