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Fed Lifts Rates for the Second Time in 2018: Winners & Losers

Zacks

The Federal Reserve lifted a key U.S. interest rate for the second time this year and signalled at a slightly more aggressive plan to tighten monetary policy in the near term. Interest rates rose again as the U.S. economy heated up and inflation crawled higher.

With the Fed hiking rates and aiming for more increases this year, banks, insurers and brokerage firms stand to gain. Meanwhile, utilities, homebuilders and gold miners are likely to lose.

Fed Gets Slightly More Hawkish

The Fed, as widely expected, raised its benchmark federal funds rate by a quarter percentage point to a range of 1.75% to 2%. Eight of the 15 Fed officials said that they expect interest rates to increase at least four times this year, up from seven in the March Fed rate meeting. The Fed’s dot plot, in fact, indicated that policy makers predict two additional rate hikes this year for a total of four increases instead of three as planned earlier.


By the end of this year, the median forecast for the federal funds rate stands at 2.4%, compared with the March forecast of 2.1%. Beyond this year, the policy-setting Federal Open Market Committee predicts that it will hike rates three times next year and one more time the following year to propel its benchmark rate up to 3.4%.

Fed’s View on Economy & Inflation

The Fed’s decision reflected an economy that is improving by the day. After all, the jobless rate is at its lowest since 2000, wages are going up and consumers are pretty confident. Fed Chairman Jerome Powell said that “most people who want to find jobs are finding them, and unemployment is low.” Lest we forget, for the first time in nearly 20 years, there are more job openings in the United States than workers to fill the positions.

Fed officials also believe that the economy doesn’t require much help at the moment. Fed has removed the language that said the central bank expected federal funds rate “to remain, for some time, below levels that are expected to prevail in the longer run.”

Powell, in the meantime, added that the Fed is comfortable with the comeback of inflation. The Fed’s preferred gauge of inflation, known as the personal consumption expenditures price index (PCE), has already touched the central bank’s 2% target during March and April. The Fed expects inflation to remain higher than 2% in the next two years. (read more: 5 Top Stocks to Beat the Fastest Rise in Inflation in 6 Years).

Winners & Losers in a Rising Rate Setting

With the Fed raising interest rates and hinting at faster hikes, certain sectors stand to gain, while some sure have a lot at stake.

Let’s take a look at the sufferers first –

Utilities

Investing in utilities won’t be a good idea in a rising interest rate scenario. Utilities are capital intensive and funds generated from internal sources do not always meet requirements. Hence, these companies have towering debt loads. Low interest rates help them pay off debts and book profits.

But higher rates along with an escalating debt level, for that matter a steep debt/equity ratio, impact the credit ratings of these utility operators. If the credit ratings go down, a company will find it difficult to borrow funds from the markets at reasonable rates, leading to a rise in cost of operations.

Home Construction

Higher federal funds rate will make it more expensive for banks to borrow money, which eventually translates into higher borrowing rates for consumers. This is surely a dampener for real estate activities and losers, affecting construction-related businesses, like homebuilders.

Mortgage rates are already on the rise. On average, the 30-year fixed mortgage rate climbed to 4.66% last month, the highest in seven years, before dropping slightly in recent weeks.

Gold

Rising rates diminish the appeal of precious metals like gold because the commodity doesn’t offer yield as high as other safe haven assets like government bonds. Higher interest rates also boost the dollar and dent demand for dollar-denominated commodities.

Following the Fed’s announcements, the ICE Dollar Index that measures the value of dollar against a basket of six major currencies, was up 0.1% to 93.898.

Now, which areas are set to make the most of a rate hike? Of course, financials!

Banks

Banks are definitely the go-to rate trade now. As a rule, higher interest rates boost bank profits as they increase the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities.

National banks like the Bank of America Corporation BAC are very rate-sensitive and have consistently seen earnings rise on a quarter-point rate hike.

Insurers

Very few companies root for a rate hike as much as those in the insurance industry. And why not? The relationship between interest rates and insurance companies is linear and straightforward, meaning the higher the rate, the greater the growth.

Insurers derive their investment income from investing premiums, which are received from policyholders in corporate and government bonds. Yields and coupons on these bonds rise in response to a rise in Fed fund rates and bank interest rates. This enables life insurers to invest premiums at higher yields and earn more investment income, expanding their profit margins.

Not only investment income, which is an important component of insurers’ top line, annuity sales should also benefit from a higher rate environment.

Asset Managers

Brokerage firms advantage significantly from an increasing rate environment since a hike in rates generally occurs during periods of economic strength and upbeat investor sentiments.

Notably, a wealth management firm like The Charles Schwab Corporation SCHW has said time and again that each quarter point increase in rates generally adds to interest revenues, much of which flows directly to pre-tax profits.

Top 5 Gainers

Given the aforesaid positives, we have selected five solid stocks from these winning areas that boast a Zacks Rank #1 (Strong Buy) or 2 (Buy).

BankFinancial Corporation BFIN operates as the holding company for BankFinancial, National Association that provides commercial, family, and personal banking products and services in Illinois. Currently, the company has a Zacks Rank #1. In the last 60 days, one earnings estimate moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings has moved 1.1% up in the same period. The stock’s estimated growth rate for the current year is 39.7% versus the Financial – Savings and Loan industry’s projected rally of 21.6%.

Morgan Stanley MS is a financial holding company. The company operates through three segments: Institutional Securities, Wealth Management, and Investment Management. The company at present has a Zacks Rank #2. In the last 60 days, six earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings has moved 4.2% up in the same time frame. The stock’s estimated growth rate for the current quarter is 32.2% versus the Financial – Investment Bank industry’s expected rally of 12.3%.

Berkshire Hathaway Inc. BRK.B provides property and casualty insurance and reinsurance, as well as life, accident, and health reinsurance. Currently, the company has a Zacks Rank #2. In the last 60 days, two earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings has moved 0.5% up in the same time frame. The stock’s estimated growth rate for the current year is 49.5% versus the Insurance – Property and Casualty industry’s projected rally of 23.4%. You can see the complete list of today’s Zacks #1 Rank stocks here.

American Equity Investment Life Holding Company AEL provides life insurance products and services in the United States. Currently, the company has a Zacks Rank #2. In the last 60 days, three earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings has moved 0.9% up in the same time frame. The stock’s estimated growth rate for the current quarter is 19.7%, in contrast to the Insurance – Life Insurance industry’s projected decline of 2.3%.

WSFS Financial Corporation WSFS provides various banking services in the United States. It operates through three segments: WSFS Bank, Cash Connect and Wealth Management. Currently, the company has a Zacks Rank #2. In the last 60 days, three earnings estimate moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings moved 0.6% up in the same time frame. The stock’s estimated growth rate for the current year is 30.9% versus the Financial – Savings and Loan industry’s projected rally of 21.6%.

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