Which shares will be the rising stars once interest rates start increasing again?

Many economists and stock market experts are predicting higher long-term interest rates in the next few years. For the moment, we will leave to one side the question of whether this prediction will turn out to be true or not. But supposing it is the case, would you not like to know which sectors will benefit from a potential rise?

Investors know that short-term and long-term interest rates are decisive influences when it comes to putting together a diversified equity portfolio. The trend in long-term interest rates, above all, has a major impact. It helps to determine which sectors and investment styles will do well and which less well.

Would it not be useful to have some kind of compass? One that helps you decide what to include in your portfolio when interest rates rise or interest rates fall? Especially now that everything is indicating the likelihood that the long-term decline in US and European long-term rates is on its last legs?

In a recent report by US investment bank JP Morgan, we came across a number of interesting charts. First of all, there is one that shows which sectors are performing above, and which sectors are performing just below the US ten-year rate.

At the top of the chart, we can see the MSCI sectors that outperform the world index when the US 10-year rate rises and it is noticeable that these are mainly cyclical sectors. In particular, we see Financials (the world’s largest banking shares), Industrials (such as Siemens, Boeing and Caterpillar) and Energy (the world’s biggest oil companies).

At the bottom of the list, we see those sectors that we rather prefer to have a lower weighting in our investment portfolio should the US 10-year rate rise. This includes more defensive sectors such as utilities (like Engie or RWE) and the manufacture and sale of food and drink (such as Nestlé, Unilever or Coca Cola).

There is a logic in this. Defensive sectors include many shares that pay out handsome dividends based on their stable earnings levels. As a result, these sectors often provide an alternative for investors who seek a more or less fixed return during periods of very low interest rates. But, if interest rates were to rise, fixed-income paper would also become more attractive for more defensive investors.

Figure 1: Correlation of sectors with the US 10-year rate

Source: JPMorgan

Conclusion

The likelihood of a rise in long-term interest rates will increase over the next few years. As we know that the US 10-year rate sets the trend for global rates, it is not a bad idea to review your equity portfolio with this in mind. The chart suggests that choosing cyclical equity sectors could be the right move if interest rates start rising.

But how does that translate into regions or investment styles? Find out more about this here.

Geert Van Herck Chief Strategist KEYPRIVATE