This is why equity investors should not be afraid of rising interest rates

Rising interest rates could set off alarms in the stock market, but strategists say be prepared, not afraid.

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

But the warning now is more like a smoke alarm and one burnt frying pan, rather than a house on fire.

“It’s less about the absolute return level and more about the speed at which it should come, and at this stage we are not worried about the speed,” said Julian Emanuel, chief equity and derivatives strategist at BTIG.

The most watched yield is the standard ten-year treasury, which affects mortgages and other loans.

It was lower at 1.16% on Tuesday, after hitting 1.2% at the key level on Monday. At that level, strategists say it will lead to 1.25%, which could start another break higher. At the end of January, the yield, which is moving opposite price, reached a fall of 1%.

Federal Profiles say yields are higher, and it is rising for several reasons.

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

Because of the federal money, better growth is expected, but it also leads to more debt and possibly inflation. This is another reason for higher returns.

Emanuel of BTIG said he would be concerned if the 10-year yield started to rush higher. He expects it to reach 1.7% by the end of the year.

However, if it moves too fast, stocks can get a rough spot. A danger zone, for example, would be around 1.34% if the yield of ten years were already at this level.

“This is likely to be a heading that will increase the growth of the markets and cause further rotation of high multiple growth stocks and up to cyclicals and value,” Emanuel said.

“Cyclists in particular can absorb this kind of rotation and make the market move sideways,” he added. “The same speculative interest that the public has shown in technology stocks … it is quite possible that at some point in 2021 you may get some speculative zeal that you have seen in such types, towards finance.”

The S&P financial sector has risen by about 6% since the beginning of the year.

Banks moved higher as the yield curve weakened. It simply means that the difference between short-term rates, such as the 2-year rate, and longer-term rates, such as the 10-year rate, has increased.

That so-called steeper curve helps banks make money, because they can borrow at the very low short-term rates and borrow longer rates.

According to Bank of America strategists, energy and technology hardware is one of the expensive sectors that could be hit by rising rates. Banks, diversified financials and semiconductors are one of the cheap sectors benefiting from rising rates, they added.

However, strategists believe that treasury yields are far from levels where they compete with equities for investment dollars.

Lori Calvasina, head of the US equities strategy at RBC, said there was no set level for the ten years that was a negative cause for equities, but ‘3% felt it was people who in the past tended to worry become.’

Calvasina said it monitors the number of companies in the S&P 500 that pay dividends above the 10-year return. At the beginning of the year, 63% of the S&P 500 companies had dividends above the 10-year return, and a few weeks later it was 56%.

“If it drops to 20% or 30%, the market could start to struggle at that level,” she said. If the market does not get into trouble at that point, there are still issues and investors are seeing less returns going forward.

The rising rate and inflation trading is especially the value cyclical rotation that started in the second half of last year as vaccine news was positive and investors started looking forward to a more normal economy in 2021.

Inflation expectations have increased, but are still low.

The ten-year break-even period, which is a market-based inflation measure, was 2.20% on Tuesday, up from around 2.1% at the beginning of last week. This means that investors are betting that inflation will average 2.2% over the next ten years.

Calvasina of RBC said as rates rise and inflation expectations rise, investors should stick to the reflection trade.

The reflection trade is when investors bet on companies that will do well if the economy improves and reopens. These include airlines, financial and industrial industries.

Calvasina also said she likes the financial sector, but some investors are under the misconception that parts of the reflection trade have already been baked in.

Energy could rise by more than 15% with the rise in oil prices this year, but other cyclical sectors, such as materials and industry, have risen by about 2% since the beginning of 2021.

Growth areas in technology and communications services can be used as a source of funding for the rotation as it has performed well, Calvasina said.

“As inflation expectations rise, you tend to see the underperformance of technology and the underperformance of communications services. The parts that are doing well are the commodities and finances,” she added.

Jonathan Golub, chief American stock strategist at Credit Suisse, says he does not expect technology to hurt as rates rise. But the stocks to be bought in this area are some of the ‘most messy’.

“I do not think technology will suffocate. I think the best way to look at it is who wins the most from an improving economy. The answer is cyclical companies … and businesses with a business problem,” he said. . “You want someone who is in the abyss, smaller capital, companies with a lot of debt.”

Golub also said that rising treasury yields are also positive for the market as it is an improving economy.

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