The inevitable rise of interest rates in 2022 has generated a very skeptical outlook on the market in the coming months. Rising interest rates tend to result in stocks losing value, yet a stronger overall economy. This occurs because the percentage return on risk-free money is rising, so people rather make money with no risk rather than take chances in the market. Stocks lower so that there is more opportunity for a large gain from holding, which happens easier at lower prices. Understanding interest rates will help you make smarter investment decisions this year, and lead you to certain market sectors.
Why do Interest Rates Matter?
Interest rates are a large influence on the spending habits of both individuals and businesses. This is because interest rates directly affect how expensive it is to borrow money, and indirectly affects certain aspects of the economy such as prices. When interest rates are low, it makes borrowing money very cheap because the amount of money you have to pay back (the interest rate) is very little on top of how much you borrow. When people know rates are low, they are more apt to do things such as buying a house and getting a mortgage or take out a loan to buy a car. Businesses on the other hand are more likely to loan money for better equipment or other expenses. With low rates in place, money flows through the economy much easier as people are much more confident they can pay the interest on their borrowed money.
As rates go up, people refrain from so much spending as they now must pay more on newly borrowed money. The reason rates cannot stay low forever is because lower rates is tied to higher inflation. With so much spending going on, prices soar to combat demand. Higher rates are necessary for the economic cycle, yet some fear the economy is not ready for it as the Covid-19 pandemic is at an all-time high in cases. Although, prolonged inflation can be much worse.
The Financial Sector
Financials have the chance to have a great 2022, even after their hot start in the first week of the year. Banks benefit from rising interest rates because this widens their profit margins. As their risk-free investments return more, they are not necessarily required to increase their interest rates to their customers (those saving money in their bank) at the same rate. With rising interest rates expected to come at 3 or 4 different points this year, the effects of larger profit margins will most likely be a trickle effect into the third and fourth quarters. Although, don’t be surprised from earlier rises from investors anticipating banks benefiting.
The Spyder ETF $XLF currently trades at about $41, and is generally one of the safer financials plays. The ETF has seen a very good rise this week, but is still primed for a great year. Using the ETF to invest in Financials will give you much less volatility compared to other stocks, but most likely a smaller dollar gain. On the other hand, single stocks can yield a higher gain, but with much more individual risk. JP Morgan ($JPM) has the largest market cap of United States banks and an impressive balance sheet, while Bank of America ($BAC) has just received a target price boost to $62 and a strong global presence. The stocks currently trade at $167 and $49, respectively, and are strong candidates to lead the financial push.
A Clean Sector to Rely On
The sector of Consumer Staples is a sector that tends to do well regardless of current economic factors. Companies in this sector sell items such as soap, laundry detergent, toothpaste, and other household items that you will always need. Even though there is economic hardships, you still must get that toilet paper. Thus, this sector never wavers too much based on current interest rates, and the volatility rising interest rates bring won’t affect the sector much.
The Spyder ETF for this sector is $XLP, and it currently trades at about $76.50. The ETF has seen a substantial 5-day decline, which could just be an even better buying opportunity. Proctor and Gamble ($PG) is a household name in this sector, which is a brand you can find all over your kitchen and bathroom. At $158, Proctor and Gamble probably won’t be at $200 by the end of the year, but it will surely have considerable gains as interest rates rise.
Interest rates influence the economy in ways necessary to current economic conditions. Understanding what the next move for interest rates is can always keep you ahead of the game.