Buy these stocks now and profit when rates rise


When the recession rocked the U.S. economy, the Federal Reserve aggressively pumped money into the economy in hopes of spurring a quick recovery. While the economy is once again on solid ground, the Fed has yet to change its near-zero interest rate policy.

That is expected to change soon.

The smart money appears to agree that the Fed will announce a small interest rate increase at its September meeting, and while a rate increase could weigh on some stocks, other stocks are likely to benefit.

The most obvious sector that is rooting for higher rates is the financial sector, since banks will be able to increase the rates they charges on loans they make. Banks tend to borrow money at short-term rates, and then lend that money out at long-term rates, and once the Fed lifts rates the gap between short and long-term rates will widen.

Banks are not the only companies that stand to benefit. Basically, any company that earns a material amount interest income stands to enjoy higher net earnings. Insurance companies instantly come to mind, but there are plenty of other stocks that also earn substantial interest related income.

The biggest fear is that higher rates will weigh on the housing market, but I believe those fears a bit overblown. Consumer confidence is strong, improvements have been seen in the jobs market, and any rate increase will likely to be small enough to keep buyers in the market. Historically, interest rates will remain extremely low, and I see no reason to expect a housing crisis in the aftermath of a slight rate increase.

What we will see is some money flowing out of the stock market and into more traditional, fixed-income investments. Some stocks will feel a little pinch, but overall I believe traders will focus on what rising rates really mean, which is that the Fed believes the economy is strong enough to endure a small rate increase.

While I do not see a huge risk from rising rates, it is understandable to be a little concerned. I don't believe that you should run out and liquidate your stock portfolio, but there are some stocks that are more immune to rate increases, and I want to take a closer look at five such companies today.

BB&T Corp.

Regional bank BB&T (BBT) stands to gain from rising interest rates. The Southeast bank stands to benefit as rising rates result in wider lending margins. The near-zero interest rate policy has made it difficult for BB&T to lift the rates it charges its customers. This will change once the Fed changes its policy. Increased regulations and new technology have resulted in higher expenses for all banks, and wider lending margins will go a long way to counterbalance the higher expenses. All financial institutions will benefit from rising rates, but regional banks have smaller trading arms than big financials, and rely more heavily on their lending business, which is why they will benefit more from a steeper curve in lending rates that will come from rising rates. BBT has a low P/E of 14.7, and analysts forecast earnings growth of 18% next year. I like the sector, and believe BBT is one of the top stocks for investors to buy ahead of rising rates.

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E-Trade Financial

While it is true that E-Trade (ETFC) generates a lot of cash from trading commissions, in fact the company generates only around 35% of its income from trading fees and commissions. Interest income is much higher for the company, and accounts for between 60% and 65% of its total net income. During the company's most-recent quarter, it reported net interest income of $267 million, and fees and service charges revenue of $55 million. You can clearly see how important interest income is to the company, and if rates start to rise, so will the amount of net interest income the company is able to generate. The stock has been trending higher, but with a P/E of 18.6, and analysts forecasting 30% earnings growth next year, there is still a lot of upside left in the stock, and once the Fed announces its decision to lift rates I believe ETFC shares will appreciate nicely.

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Progressive Corp.

The insurance sector should also benefit from rising interest rates. In this sector, I like Progressive (PGR). The reason insurance companies stand to benefit is something known as “the float”. Insurance companies collect money in the form of premiums, and then get to hold that money until the time comes to pay out customer claims. The float is the time between the two events when insurance companies are able to invest the money. In essence, insurance companies are getting interest free loans that they can turn around and invest. When interest rates are high, insurance companies can earn more money on their reserves. Investing the float will almost always be in an insurance company's favor, but the higher the rates, the better. PGR has been trending higher, and while analysts only expect a modest 2% earnings growth next year, shares are trading very cheap with a P/E of 13.6. 

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Automatic Data Processing

We already discussed the power of “the float” when we looked at Progressive (PGR), and Automatic Data Processing (ADP) is another company that has a large float which stands to benefit from rising interest rates. ADP has around $22 billion in client funds that it invests. For 2015, ADP expects to earn somewhere between $380 million and $390 million just from the interest it is able to generate with its float. This translates to around one-quarter of the company's total forecast earnings for the year. As interest rates start to rise, the interest income ADP is able to generate will also increase, and ADP shares will move higher. ADP currently has a P/E of 27.5, which is a little high, but analysts forecast 13% earnings growth for 2017 versus 2016, so the P/E is not that out of line considering the high forecast earnings growth forecast.

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Macy's Inc.

The consumer discretionary sector is not one that immediately comes to mind as a sector to benefit from higher interest rates, but in fact it does. Not because higher interest rates help boost income, but because higher rates tend to be a result of improvements in the overall economy. Retailers such as Macy (M) are set to benefit as an improved jobs market leads to higher discretionary spending by consumers. Consumer confidence remains upbeat, and as a result retailers such as Macy’s have been strong. M has been trending higher over the last two years, and with a P/E of just 16.2, and 10% forecast earnings growth, I see additional upside to the stock. When the Federal Reserve moves to allow interest rates to rise, a lot of consumers will take an even more upbeat view on the overall economy, and discretionary spending should rise, and push M higher as a result.

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Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va.


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