It was no surprise to most investors this week when the Federal Reserve opted to issue its first interest rate hike of 2017. The Fed raised its target rate by 0.25% to a range of 0.75%—1.0%. It’s been quite a while since the Fed maintained a consistent schedule of interest rate hikes. Here’s a look at what it could mean for your investment portfolio.
Rising interest rates will likely have a negative impact on bond prices. As interest rates rise, investor borrowing costs increase. This phenomenon results in less investor demand for bonds and lower bond prices. Longer-dated, fixed-rate bonds will be hit hardest.
Real estate investments will also likely suffer. There is a historical inverse correlation between REIT prices and interest rates.
Why? REITs and other high-dividend stocks are the only place to go for yield when interest rates are low. Once they start to rise, fixed-income investors have the option of jumping to Treasury bonds or even CDs, which are perceived as much lower-risk.
In addition, high-yielding stocks in the Utilities and Consumer Staples sectors could also suffer for the same reason.
At the same time, there are plenty of potential market beneficiaries as well. While conventional market wisdom suggests investors would shy away from gold when interest rates rise, historical evidence paints a quite different picture. During the past six Federal Reserve tightening cycles, gold prices have averaged an 11.2 percent gain per cycle.
Bank stocks are also poised to benefit from rising interest rates. Banks profit off of a metric called net interest margin, which is the difference between the interest rate they pay out on deposits and the rate they charge on loans. When interest rates are higher, banks have a bit more wiggle room to expand net interest margins.
In addition to bank stocks, bank loan ETFs, such as the PowerShares Exchange-Traded Fund Trust II (NYSE: BKLN), can generate higher income as interest rates rise. The BKLN ETF already pays out a generous 4.2 percent yield.
Finally, the rate of return on money market accounts also rises along with interest rates, so any cash holdings will start to be much more productive at some point.
While the ideas above are mostly based on historical trends and market tendencies, there is a more direct way for investors to play rising interest rates. The Sit Rising Rate ETF (NYSE: RISE) is specifically designed to provide levered returns as interest rates rise. The RISE holds short positions on Treasury bonds and is structured to deliver a 10x return on interest rate changes. If economists are correct in anticipating three Fed rate hikes in 2017, the RISE would theoretically deliver a 7.5% return on the year.
Another direct option is the WisdomTree Trust (NASDAQ: AGND). The AGND is designed to rise as bond prices fall and should also mirror potential moves in interest rates.
Traders considering either of these ETFs should be aware that their liquidity is extremely low, which could likely make entering and exiting a position difficult to do.
Disclosure: the author holds no position in the stocks mentioned.
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