The stock market has had quite a ride so far in 2022, with the major market averages all declining to kick off one of the worst Januarys in half a century.
By contrast, the economy has been chugging along, with businesses hiring and wages increasing. There are many threats to the economy that remain, of course. Chief among them is the continued shortage of labor.
However, one likely coming change is the expected hike in interest rates by the Federal Reserve. These changes are likely to have a major impact on the economy. In spite of these potential increases, there are many stocks that may prove to be sound investments.
What is Expected in Terms of Interest Rates?
Interest rate increases are likely on the horizon.
In interviews and according to numerous reports, it is expected that the Federal Reserve will raise interest rates at least three times this year. At the same time, the Fed is also expected to slow down its COVID-19 related stimulus measures. All of this is being done in order to slow inflation, which has proven to be a great economic headwind.
Most forecasters expect more interest rate hikes than were initially expected, with a consensus emerging around three interest rate hikes, instead of the two originally forecast. This would represent a major increase and the first time in years that interest rates were hiked so many times.
What Effect Does This Have on the Stock Market?
The interest rate charged by the Federal Reserve determines the interest charged to major banks that borrow from the Fed.
In order to make those payments, banks will then charge higher interest rates on consumers. This, of course, has a major ripple effect.
Other institutions will typically increase their interest rates as well. This has the effect of taking money “out” of the economy, as consumers and corporations have to pay more in interest rates – thus leaving them with less money for other expenses.
Typically, interest rate hikes are bad news for the stock market. This is the case for many reasons:
- It costs more money for major businesses to borrow money, as they now have to pay more in interest charges. This, in turn, typically leads to slower growth and less job hiring.
- Businesses will have added costs, leading to thinner profit margins and a reluctance to take on new debt.
- Consumers have less money to spend, as they have to pay more money on credit card interest rates and loan repayments.
This hurts some sectors of the economy more than others. For example, debt-intensive lines of business fare worse, as they have to pay more in interest rates, thus leading to slower growth. For example, manufacturing companies – which need to constantly be expanding or upgrading facilities – typically do poorly in high-interest rate environments.
What Stock Sectors Do Better with Raised Interest Rates?
Just like all things related to the stock market, some businesses will do well, even while others are floundering. Indeed, there are some sectors of the stock market that do better in a higher interest-rate environment – or at least don’t do as poorly. These include:
- Banks. Banks can turn a higher profit, thanks to higher interest rates and increased inflation.
- Insurance companies. A huge part of an insurance company’s financial model is to invest assets in long-term financial instruments, such as bonds. Bonds do better when interest rates are higher. As a result, insurance companies get a better return on investment when interest rates are higher.
- Consumer staples. These stocks tend to be a “safe” investment in times of high inflation, as they are relatively unaffected – after all, people will need to buy standard consumer staples, such as toilet paper, regardless of what inflation is. As a result, consumer spending shifts towards more “basics,” thus boosting this sector.
- Energy companies. Like consumer staples, demand for energy stocks is relatively unchanged, regardless of the inflationary environment. People will still spend their money on energy, and this better positions energy companies to weather the storm that is caused by high inflation and higher interest rates.
- Real Estate Investment Trusts (REITS): This class of stock is involved in owning property and collecting rent. They are able to do well during inflation because of the method in which they earn a profit: Rent collection. They can simply survive high inflation by increasing rents.
- Healthcare: People will need healthcare no matter what impact inflation has. As such, healthcare stocks are typically safe investments in times of high-interest rates and inflation.
What Stocks May Be Good Investments?
As you can see, higher interest rates are not terrible for every stock – in fact, for some, they can be very positive. Here’s a list of companies to consider for investment in a higher interest rate environment:
- Exxon Mobil (XOM): As one of the world’s largest energy companies, Exxon Mobil is well-positioned to weather an inflationary storm. It has performed extremely well in the past year of inflation, with its share price increasing by more than 70%. It offers a healthy dividend of 4.35%, and has a buy or hold rating from virtually every analyst surveyed by the Wall Street Journal. Its worldwide presence means that it is exposed to inflation worldwide, yet it has continued to thrive, turning a profit and seeing major share price increases.
- Johnson & Johnson (JNJ): JNJ is a very broad company, involved in an array of consumer staples and medical technologies – two fields that have proven to be relatively resilient against medical changes. Johnson & Johnson has also done well on the strength of its COVID-19 vaccine, despite some of the issues that its vaccine has run into. It has increased 12.27% in the past year, and all analyst ratings are either buy, hold, or overweight.
- Avantor (AVTR): This Fortune 500 company is heavily engaged in chemicals and medical technology, helping to keep its demand outside of any dangers posed by high insurance rates. Like other companies on this list, it has performed well in the past year, with its 28.78% growth outpacing the growth of the NYSE in general. In the short term, it continues to perform well, showing major increases along with all financial metrics. This has also earned it high rankings from analysts that monitor the stock.
- Sun Communities (SUI): Sun Communities is a top-performing REIT, with its stock increasing 31.18% in the past year. It has solid fundamentals and a diverse array of real estate holdings, thus helping to immunize the company from potential over-exposure in one sector of the real estate market.
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