Stock market performance during rising interest rates
Rising rates are good for the stock market, but only to a certain point. That’s because they’re usually a signal that the economy is growing fast and is about to reach its peak. This situation is met with inflation concerns, which will cause central banks to step in.
The aim of rate rises is to slow growth down, not stop it in its tracks. So, for a while, they’re met with optimism and increased spending, which is positive for the stock market as companies are likely to see more profits.
But eventually, rising rates can also be seen as a sign that the current economic cycle is ending and that another contraction could be around the corner. Fears of a recession will lead to a reduction in spending and less lending due to the risk of default becoming more likely.
The increases in interest rates does also make borrowing more difficult for companies as the cost of lending goes up, which drives down business growth and expansion. So, as consumers focus more on saving, it can lead to a decline in profits for businesses.
The same goes for investors, as the higher rates also make saving more appealing, which can cause a shift away from risk-on assets – such as stocks.
Which sectors and stocks perform well when rates rise?
When interest rates rise, there are a few sectors and stocks that tend to outperform the rest of the market. But, it’s important to understand which point of the economic cycle you’re currently in because it does lead to changing sector preferences.
When there are rising rates but the economy is still growing, then the finance sector, industrial producers, consumer discretionary stocks and retailers all tend to do well off the back of increased spending.
But once the cycle has reached its peak, consumers start choosing to put it into savings instead, which causes stocks such as consumer staples, healthcare and gold miners to become more popular in preparation for an economic contraction.
It’s important to note that while these sectors traditionally do well when rates rise, they might not always. You should make sure to do your own research before taking a position and have a risk management strategy in place to prepare for changes in the economic cycle and market sentiment.
Let’s take a look at some different sectors and how they fare in rising-rate environments.
When rates start to rise, it can increase the profit margins of financial institutions – including banks, insurance companies and brokerages.
For banks, although borrowing becomes less attractive, loan repayments become easier due to higher consumer income. The flip side of this is that they’ll have to pay out more as interest on savings accounts – although normally the spread between what they spend and what they earn on debt gets wider.
Higher rates also mean that insurance companies experience periods of growth. As consumer spending increases, the more car purchases and home sales there are, which translates to more insurance policies. But once consumer spending starts to fall, the number of new policies will decline.
Brokerages also benefit from rising rates, as a healthy economy usually increases the amount of trading activity and interest rate income.
Consumer discretionary stocks
As employment increases and wages rise, consumers have more disposable income to spend money on goods that aren’t deemed ‘essentials’ or consumer staples. Examples include manufacturers of durable goods – such as cars, furniture, white goods and jewellery – as well as hotels, fast food and restaurant stocks.
Although you can focus on the individual shares of these companies – such as Nike, Marriott International and Ford – you can get exposure to a whole range of consumer discretionary stocks using an ETF. The most popular of which is the Consumer Discretionary Select Sector ETF, which includes the likes of Amazon, Home Depot and McDonald’s.
These are often called cyclical stocks, as they rise and fall in line with the business cycle.
Consumer staples – the companies that produce food, beverages and energy – are more resistant to economic downturns. These non-cyclical stocks, more commonly known as defensive stocks, are more suitable for preparing for the downturn that inevitably comes. They’re extremely popular before and during recessions, as people still need food, heating and homes regardless of the state of the economy.
The industrial sector is made up of companies that produce machinery, equipment and supplies for construction.
Their performance is intrinsically linked to the health of the economy because a growing economy causes housing starts, infrastructure projects and transport needs to increase, which in turn boosts profits. The flip side of this is that the industrial sector is one of the first to contract when a recession hits and costs are cut.
Popular industrial stocks include Boeing, General Electric, Caterpillar and Union Pacific Corporation. You could also get exposure to the industrial sector using indices and ETFs.
Gold mining stocks
When interest rates are rising, commodities typically decline in price because the fees associated with holding them increase too. So, initially when rates rise, a lot of gold mining firms would see greater costs.
However, gold is known as a safe haven during periods of economic downturn. So, when high interest rates mean fears of a recession start to grow, you’ll commonly see investors turn to the precious metal. This means that companies involved in the mining and refining of gold outperform the market.
How to trade sectors and shares with City Index
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To get started, follow these quick steps:
- Open a City Index account, or log in if you’re already a customer
- Search for the sector or company you want to trade
- Choose your position and size, and your stop and limit levels
- Place the trade
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