Analysis: Higher interest rates? Not a problem for some U.S. stocks

Tue Jul 16, 2013 2:19pm EDT
 
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By Rodrigo Campos and Alison Griswold

NEW YORK (Reuters) - So much for higher interest rates taking a bite out of the stock market. Bond yields have risen sharply in the last two months, but the U.S. stock market has more than survived, with the S&P 500 and Dow industrials notching new all-time highs this week.

Rates are likely not finished climbing, however, and equity investors need to be prepared. Expectations that the Federal Reserve will soon start to pare its $85 billion a month bond purchasing program boosted the U.S. 10-year Treasury yield as high as 2.75 last week, climbing more than 110 basis points since May 1.

Corporations don't like to see borrowing costs rise, and the additional yield offered in fixed-income investments should draw back some of the risk-averse investors who have been digging for yield in the stock market.

But if the outlook for economic growth continues to improve, there are plenty of spots in the stock market that not only won't be hurt, but will benefit from rising yields.

"High interest rates generally are perceived as not great for the stock market. But if you go back in history, during the early stage of an interest rate rise, the stock market tends to do well," said Yu-Dee Chang, chief trader of ACE Investments in Vienna, Virginia. "I think that's the stage we're in."

Sectors that could benefit include regional banks, helped by higher long-term rates that improve lending margins. For the larger lenders the increase could be offset by write-downs in their bond holdings. Technology and smaller stocks that do well during periods of rising growth also are poised to outperform.

On the flip side, companies with higher debt levels dependent on borrowing may find their stocks languishing. There are two dozen S&P names, not including the financials and utilities, with debt levels exceeding 65 percent of their market value, and their borrowing costs would rise if they need to roll over debt issues.

Meanwhile, those companies whose appeal primarily stems from their status as a high-yielding alternative to bonds, such as utilities, have been hit since May as rates started to rise.   Continued...

 
Traders work on the floor at the New York Stock Exchange, July 16, 2013. REUTERS/Brendan McDermid