Investors can beat the Fed at its own game: Here's how
No matter what the Federal Reserve does with interest rates this week, investors should already know the game plan.
Investors are braced for rates to rise, if not this month, soon. Higher rates aren't toxic to all stocks. Energy stocks like Helmerich & Payne (HP), materials stocks like Nucor (NUE) and health care stocks like Humana (HUM) have actually performed relatively well during periods when the Fed is raising rates going back to 1971, according to a USA TODAY analysis of data from S&P Global Market Intelligence that looks at current members of the Standard & Poor's 500. These types of stocks are in stark contrast to those in the consumer discretionary sector, like Mattel (MAT) and Ford (F), in addition to financials like Lincoln National (LNC), which have tended to lag when the Fed is hiking rates.
Understanding these key market dynamics is part of surviving the Fed's changes no matter if higher rates come now, or later. "We see the U.S. Federal Reserve on hold this month but believe a late-2016 interest rate increase is very likely," says Richard Turnill, global chief investment strategist at BlackRock, in a note to clients.
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Investors know the odds of an interest rate hike sometime this year are good.
More than half of traders think short-term interest rates will be higher by the end of the year, while just 12% think the Fed will boost short-term interest rates in the meeting this week.
Higher interest rates aren't good news for most stocks. Stocks' returns are about 44% lower when the Fed is hiking rates than usual, according to research by Robert Johnson, CEO of the American College of Financial Services. The S&P 500 has risen just 4.4% during the previous rate-hike periods since 1971, says Sam Stovall, U.S. equity strategist at S&P Global.
3 market scenarios based on Fed's next move
But that doesn't mean if the Fed raises rates that you have to accept lower returns. Investors are wise to understand there are still ways to profit, including:
• Staying exposed to energy. Energy stocks have been the place to be when the Fed is hiking rates. The sector has delivered 17.8% average gains during the past 11 rate-hiking periods, including the one the market is in now, according to Stovall. Staying the course with energy takes courage. Collapsing oil prices have been painful for investors for years, pushing the Energy Select SPDR (XLE) fund down by a third since the middle of 2014. Helmerich & Payne, an oil and gas driller, has been the best energy stock in the S&P 500, rising an average of 38.4% during the previous hikes. Three of the five best-performing stocks during previous rate hike cycles were all in the energy sector.
BEST FIVE S&P 500 STOCKS DURING RATE HIKES
Company, symbol, average since 1971 rate hikes
- Humana, HUM, 58.3%
- Nucor, NUE, 55.4%
- Helmerich & Payne, HP, 38.4%
- Apache, APA, 32.2%
- Murphy Oil, MUR, 30.8%
Source: S&P Global Market Intelligence, USA TODAY
• Playing the materials bump. Materials companies, which make industrial goods like steel and copper, are the next best place to be when the Fed is boosting rates. The sector has delivered an average 7.1% gain during rate-hiking periods. Nucor, a steel maker, has been the best materials stock, rising an average of 55.4%. Both materials and energy stocks do well because investors see them as being safe harbors if inflation picks up, Stovall says.
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• Beware of consumer discretionary and financials stocks. Financials and companies that make goods consumers can put off buying get hit when the Fed is raising rates. The idea behind the move is that higher rates slow the economy and make consumers less confident to spend and borrow. Consumer discretionary and financials stocks are the only ones to post average declines when rates are rising, to the tune of 1.6% and 1.4%, respectively. "Consumer discretionary (stocks) and financials don't do well as investors expect the Fed to begin raising rates and reducing either demand or profit margins," Stovall says.
WORST FIVE S&P 500 STOCKS DURING RATE HIKES
Company, symbol, average since 1971 rate hikes
- Mattel, MAT, -19.9%
- Ford Motor, F, -17.7%
- Goodyear Tire & Rubber, GT, -15.4%
- Pinnacle West Capital, PNW, -12.5%
- Eaton, ETN, -10.9%
Source: S&P Global Market Intelligence, USA TODAY
HOW ALL THE SECTORS PERFORM DURING FED HIKES
Sector, Average change during rate hikes back to 1971
Energy, 17.8%
Materials, 7.1%
Health care, 5.8%
Industrials, 4.9%
Utilities, 4.9%
Telecom, 4.3%
Technology, 3.7%
Consumer staples, 1%
Financials, -1.4%
Consumer discretionary, -1.6%
S&P 500 4.4%
Source: S&P Global Market Intelligence