Wall Street has been on choppy ride since the start of 2022 due to rising rate worries. At the end of Jan 26, 2022, the yield on the benchmark 10-year Treasury note jumped 7 basis points to 1.85%. The yield on the 30-year Treasury bond increased 4 basis points to 2.16%. The yield on the benchmark 2-year Treasury note surged 11 bps to 1.13%. Rates have been rising in the United States on the Fed’s rate hike bets.

Higher inflationary expectations emanating from supply chain disruptions as well as higher crude prices should make Fed members comfortable with rate hikes in the coming days. The Nasdaq, heavy on technology and growth stocks, plunged 7.6% last week, marking its worst week since March 2020, while the S&P 500 (down 5.7%) and the Dow Jones (down 4.6%) saw considerable losses. The Nasdaq Composite has lost 12% this year as investors continue to walk out of the high-growth tech shares on surging interest rates.

Federal Reserve policy makers indicated that they are likely to enact their first interest rate hike since 2018 in their March meeting to combat sky-high inflation. As of Jan 26, 2022, CME’s FedWatch Tool said that there are 32.6% chances of 2022 closing out with 125-150 bps of rates while a 28.1% probability is there for the year to end at 100-125 bps of rate.

Should You Fear Rate Hike?

Signs of a recovery in the U.S. economy, though not brisk in every area, are surely more than what we saw last year. Per a Reuters article, big U.S. banks believe that the current spending patterns indicate consumers’ wellbeing. Healthy consumers having cash in the bank, are looking forward to spending as well as borrowing.

Although stocks are overvalued by some measure, an influence of consumers’ prosperity on the stock market will only be natural. Yes, stocks may also slip due to the fear of gradual creases in cheap dollar inflows. But, this hiccup maybe short term in nature.

Wealth Effect in Play?

The Conference Board forecasts that U.S. real GDP growth will rise to an annualized rate of 6% in Q4 2021 versus 2.3% growth in Q3 of 2021, and 2021 annual growth will reach 5.6% (year over year). The U.S. economy is forecast to expand 3.5% in 2022 and 2.9% in 2023.

And in a growing economy, most sectors surge from a wealth effect, with a few of the more cyclical corners making the most of this run-up. These industries often sag in a slumping economy, but are the biggest winners when rays of hope are seen.

Against this backdrop, below we highlight a few sector ETFs that tend to win in a rising rate environment.

Financials – Financial Select Sector SPDR Fund (XLF)

Talks about the March Fed rate hike have boosted the space lately. The steepening of the yield curve is a tailwind for banking stocks as these improve banks' net interest margins. This is because the interest rates on deposits are usually tied to short-term rates while loans are often tied to long-term rates.

Consumer Discretionary – AdvisorShares Restaurant ETF (EATZ)

The consumer sector is cyclical in nature. The sector can be considered a barometer of rising income levels of consumers of an economy. However, online consumer ETFs performed well in the peak of lockdown phase. With the economic reopening gaining ground now, we expect stay-at-home stocks to underperform and move-out-of-home stocks to take an upper hand now.

Foot traffic at the top 10 coffee chain performers was up 2.8% compared to two years ago in June 2021, Placer.ai found out (per a Yahoo Finance article). But in November 2021, the coffee space witnessed an 8.4% jump in foot traffic compared with the 2019 levels, while December experienced a surge of 7.5% despite Omicron. The data demonstrates consumers’ willingness to spend outside home.

Materials – Materials Select Sector SPDR Fund (XLB)

The industrials and materials sectors too are likely to perform better in a rising rate environment. As the U.S. manufacturing data are coming in upbeat, the industrial sector should hold up well. U.S. economic activity in the manufacturing sector grew in December, with the overall economy marking the 19th successive month of growth. This, in turn, would boost the demand for materials. Investors should note that material prices have been steady in recent months.

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