Where do Investors Turn when Interest Rates Rise?

Where should investors look in a market where interest rates are rising? Are there businesses that will do better than others will? Which should you avoid if interest rates keep going up?

All of these are good questions when the economy is entering a prolonged cycle where it appears likely that interest rates will continue to rise. Clearly, some companies will suffer more than others will when interest rates rise.

The trick is to identify the companies that will benefit or at least hold their own from rising interest rates.

Interest sensitive businesses like mortgage lenders and automobile sales will likely suffer when interest rates hit the point where it begins to hurt. Years of low interest rates have conditioned borrowers to look at them in a positive light.

Prices Going Up

At some point, rates will rise beyond that emotional level where consumers no longer consider them a positive or at worse neutral in purchase decisions. When interest rates hit that mark – and it will differ for each consumer – they will become a drag on the product or service.

Low rates have made home mortgages, the refinancing of mortgages and home equity loans the hottest consumer lending products in recent history. Higher rates will take the edge of these products and the companies that provide them.

Ironically, higher rates may help credit card providers who have lost credit balances when customers have used home equity loans to pay off credit card debt. The credit card companies don’t need the interest spread, but would love to carry more of their customers’ debt.

Consumer Stables

Consumer staples (think toilet paper) are largely unaffected by interest rates, although the stocks of these companies will seldom get your blood flowing with excitement.

Higher interest rates are a cost of business passed on to customers when possible. A problem arises when companies must compete with foreign competitors who have access to capital at lower or at least stable interest rates. To remain competitive, domestic companies may not be able to raise prices as fast as interest rates climb. This ultimately squeezes profits.

Higher interest rates can cool an overheated economy to prevent inflation, which is the most dangerous of all economic maladies. However, if interest rates climb too far, too fast, they can stymie growth and cripple the economy rather than cool it. A fine line must be walked.

Companies to Watch

In periods of rising interest rates, these types of businesses are among those that may benefit or at least hold their own:

• Credit card companies and certain other financial companies
• Consumer staples
• Service companies that don’t rely on large amounts of debt to either finance their business

Companies that May Take a Hit

Rising interest rates can spell big trouble for some businesses that depend on borrowed capital or that sell a product that their customer must finance. For example:

• Mortgage lenders
• Real estate developers
• Automakers

Conclusion

Obviously, this is not an exhaustive look at who will win and who will lose in the rising interest rate environment. However, with some thought investors can watch for opportunities and avoid obvious pitfalls.