Hence, equity investors need not fear rising interest rates

Rising interest rates may cause alarms in the stock market, but strategists say be prepared, don’t be afraid.

For now, interest rates are rising with the idea that inflation will rise too.

But the warning at this point probably looks more like a smoke detector and a burnt skillet than a house on fire.

“This is less about the absolute level of returns and more about the speed at which it takes to get there, and right now we’re not concerned about speed,” said Julian Emanuel, chief equity and derivatives strategist at BTIG.

The best viewed return is the benchmark 10-year Treasury, which affects mortgages and other loans.

It was lower at 1.16% on Tuesday, after hitting the main 1.2% on Monday. At that level, strategists say it would move towards 1.25%, which could launch another break higher. At the end of January, the yield, moving against the price, hit a low of 1%.

Bond professionals say interest rates are rising and they are rising for a variety of reasons.

A major factor is Covid’s fiscal stimulus, the $ 900 billion approved in December and the $ 1.9 trillion plan now running through Congress.

Better growth is expected because of the federal money, but that also results in more debt and possibly inflation. That’s another reason for higher yields.

BTIG’s Emanuel said he would be concerned if the ten-year yield went higher racing. He expects it to reach 1.7% by the end of the year.

However, if it moved too quickly, the stocks could find themselves in a difficult situation. For example, a danger zone would be about 1.34% if the 10-year yield reached that level as early as this month.

“That would likely be a headline that would limit the markets’ gains and cause further rotation away from high multiple growth stocks to cyclicals and value,” said Emanuel.

“Cyclicals, in particular, can accommodate this kind of rotation and move the market sideways,” he added. “The same speculative interest the public has shown in technology stocks … it is quite possible that sometime in 2021 you could get some degree of speculative fervor that you have seen with those types moving towards financial services.”

The S&P financial sector is up about 6% since the beginning of the year.

Banks have risen as the yield curve steeps. That simply means that the difference between the short-term rate, such as the 2-year, and the longer term, such as the 10-year, has increased.

This so-called steeper curve helps banks to make money, because they can borrow at the very low short-term interest rate and borrow for a longer period of time at a higher interest rate.

Bank of America strategists say energy and technical hardware are among the expensive sectors that could be hurt by rising rates. Banks, diversified financial institutions and semiconductors are among low-cost sectors benefiting from rising interest rates, she added.

But strategists say government bond yields, while rising, are far from competing with stocks for investment dollars.

Lori Calvasina, head of US equities strategy at RBC, said there is no set 10-year level that is a negative trigger for stocks, but “3% feel people were concerned about it in the past.”

Calvasina said she keeps an eye on the number of companies in the S&P 500 that pay dividends above the 10-year yield. At the start of the year, 63% of S&P 500 companies had dividends above the 10-year yield, and a few weeks later it was 56%.

“If it falls to 20% or 30%, the market could start to struggle at that level,” she said. If the market doesn’t get into trouble at that point, there are still problems and investors see less future returns.

Rising interest rates and inflation trading is to a large extent the value-cyclical spin that began in the second half of last year as vaccine news was positive and investors began to look to a more normal economy in 2021.

Inflation expectations have risen, but they are still low.

The 10-year break-even, a market-based inflation measure, was 2.20% on Tuesday, up from about 2.1% early last week. That means investors are betting that inflation will average 2.2% over the next 10 years.

RBC’s Calvasina said that as interest rates rise and inflation expectations rise, investors should stick to the reflation trade.

The reflation trade is when investors bet on companies that will thrive when the economy improves and reopens. This includes airlines, financial institutions and industrial companies.

Calvasina also said she loves the financial sector, but some investors have the misconception that parts of the reflation trade are already ingrained.

Energy may have risen more than 15% on the rise in oil prices this year, but other cyclical sectors, such as materials and manufacturing, are only up about 2% since early 2021.

Growth areas in technology and communications services can be used as a funding source for the rotation, as they have done well, Calvasina said.

“As inflation expectations rise, you see the underperformance of technology, the underperformance of communications services. The parts that usually do well are commodities and financial services,” she added.

Jonathan Golub, chief US equity strategist at Credit Suisse, says he doesn’t expect the technology to be too hurt when interest rates rise. But the stocks you can buy in this environment are among the ‘junkiest’.

“I don’t think technology is getting stifled. I think the better way to look at it is who gains the most from an improving economy. The answer is cyclical companies… and companies with a business problem,” he said. . “You want someone on the precipice, a smaller cap, companies with a lot of debt.”

Golub also said rising government bond yields are also positive for the market as they represent an improving economy.

“The most exciting event in the planet’s history will not be the end of World War I, the end of World War II, but the reopening of the economy this summer,” he said.