That is why equity investors should not fear rising interest rates

Rising interest rates can raise alarms in the stock market, but strategists say be prepared, without fear.

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

But the alert at the moment probably sounds more like a smoke alarm and a burning frying pan than a burning house.

“This is less about the absolute level of returns and more about the speed with which it takes to get there, and right now we don’t care about speed,” said Julian Emanuel, BTIG’s chief equity and derivatives strategist.

The most watched yield is the 10-year benchmark Treasury, which influences mortgages and other loans.

It was lower on Tuesday, with 1.16%, after touching the 1.2% level on Monday. At this level, strategists say it would head towards 1.25%, which could throw another pause higher. At the end of January, the yield, which moves against the price, reached a low of 1%.

Bond professionals say yields are going up and rising for several reasons.

One of the big factors is Covid’s fiscal stimulus, the $ 900 billion approved in December, and the $ 1.9 trillion plan that is now making its way into Congress.

Better growth is expected due to federal money, but this also entails more debt and potentially inflation. This is another reason for higher yields.

Emanuel of BTIG said he would be worried if ten-year performance started to move forward. It expects to reach 1.7% by the end of the year.

However, if it moved too fast, the actions could become difficult. For example, a danger zone would be approximately 1.34% if the ten-year yield reached that level as early as this month.

“Probably, this would be a stock that would limit the growth of markets and cause a new rotation, outside of high multiple growth stocks, and turn them into cyclical and value stocks,” Emanuel said.

“Cyclicals, in particular, could absorb this kind of rotation and keep the market moving sideways,” he added. “The same speculative interest that the public has shown in technology stocks … it’s entirely possible that at some point in 2021, you might get a degree of speculative fervor that you’ve seen in these types, heading into funding.” .

S&P’s financial sector has grown by around 6% since the beginning of the year.

Banks have increased as the yield curve has intensified. This simply means that the difference between short-term rates, such as two-year rates, and longer-term rates, such as ten-year rates, has widened.

This so-called steeper curve helps banks make money, as they can borrow at very low short-term rates and lend at a higher rate for longer periods of time.

Bank of America strategists say energy and technology hardware is among the expensive sectors that could be hurt by rising rates. Banks, diversified financial resources and semiconductors are among the economic sectors that benefit from rising rates, they added.

But strategists say Treasury yields, while rising, are far from the levels at which they compete with stocks to get investment dollars.

Lori Calvasina, head of U.S. equity strategy at RBC, said there is no set level in ten years that is a negative trigger for stocks, but “3% feel that’s where people of the past tends to worry. “

Calvasina said it controls the number of S&P 500 companies that pay dividends above ten-year yields. At the beginning of the year, 63% of S&P 500 companies had dividends above ten-year returns, and several weeks later it was at 56%.

“If it falls to 20% or 30%, at that level the market could start fighting,” he said. If the market has no problems right now, there are still problems and investors have less return in the long run.

Rising rate and inflation trade is largely the rotation of cyclical stocks that began in the second half of last year, as news of vaccines was positive and investors were beginning to expect a stronger economy. normal in 2021.

Inflation expectations have been rising, but remain low.

The 10-year imbalance, which is a measure of market-based inflation, stood at 2.20% on Tuesday, up from 2.1% earlier last week. This means that investors are betting on an average inflation of 2.2% in the next 10 years.

RBC’s Calvasina said that as rates rise and inflation expectations rise, investors should keep up with the inflation trade.

Reflation trading is when investors bet on companies that will do well when the economy improves and reopens. This includes airlines, financial and industrial companies.

Calvasina also said he likes the financial sector, but some investors believe some parts of the inflation trade are already cooked up.

Energy may increase 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 early 2021.

Calvasina said the growth areas of technology and communications services could be used as a source of funding for the rotation.

“As inflation expectations rise, we tend to see the low performance of technology, the low performance of communications services. The parts that tend well are commodities and finance,” he added.

Jonathan Golub, Credit Suisse’s chief U.S. equity strategist, says he doesn’t expect the technology to go bad as rates rise. But stocks to buy in this environment are among the “youngest”.

“I don’t think technology is drowning. I think the best way to look at it is to earn more with an improving economy. The answer is cyclical companies … and companies that have a business problem,” he said. . . “You want someone who is on the precipice, with a smaller limit, companies that have a lot of debt.”

Golub also said increases in Treasury yields are also positive for the market as they represent an improving economy.

“The most exciting 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.