“Lift off! We have a lift off!”
That’s the sentiment that echoed through the financial markets today as the FOMC meetings were concluded and Janet Yellen announced that the Fed was raising the policy rates by .25%, officially ending the Zero Interest Rate Policy enacted as a reaction to the recession.
It remains to be seen how the markets and the economy will react to the raise long term. Historically, during a raise, the markets have tended to decline, averaging a -20% return in the first year after a rate increase. However, the Fed is likely to take a lot of time before they get rates back up to where it’ll be considered normal so it’s not guaranteed that the markets will decline since monetary policy is still very accommodating.
However, for an investor looking to trade the new environment, the question is: what stocks are likely to benefit from the current increasing interest rates? It’s something I’ve been looking at for a while, since everyone has been expecting this for a while.
My first choice would be insurance companies, especially the property and casualty ones. Here, my favorites are Geico and Traveler’s. You’d have to buy shares in Berkshire Hathaway to invest in the former, but the latter is trading directly on the NYSE under the stock symbol ‘TRV’. TRV has already gained 1.05% since the announcement. However, I expect it to increase even further in the coming weeks/months. The reason is that Property and Casualty (P&C) insurance companies hold a lot of the money they collect from premiums (known as float) in fixed income securities that are less risky than stocks. Usually, the company makes interest income from their float which it gets to keep for itself as income. However, since the zero interest era, most of that has been earning near and sometimes even less than 0 for the company. Now, with the rate lift, those fixed incomes will make quite a good amount of money for the insurance company. For Traveler’s insurance, those fixed assets amount to around $65 billion worth. Accounting for the fact that fixed income prices tend to fall when rates increase, let’s revise that down to $60 billion. Earning .25% on that comes up to about $150 million. When you go through their entire yield curve, including the longer duration ones, the company will be making anywhere between $450 to $900 million more, which adds almost $2.00 to its earnings per share in the next year. That should push it’s stock up to $135 from $114.50 right now, possibly higher if its earnings multiples climb along with market sentiment and momentum.
Another company I would really consider at the Moment is Wellsfargo. They’re one of the most stable of all banking companies, with a healthy mortgage portfolio which should benefit nicely from the rate hike in the form of higher mortgage payments and higher yields on it’s securitized mortgage-backed assets. Going through the details of their holdings right now would be redundant, if you know what to look for you can go through their 10K reports and make the calculations. I’m doing it right now, and so far it looks good, but I’ve not fully made my conclusions.
The general principle here is to look at companies which carry floats or earn interest on fixed income securities, and who benefit from an improving credit and economic environment. So consider housing companies, payroll processors, lenders, insurance companies, banks, etc.
Do your research before you invest.