Bank of America, Citi, Walmart, Costco: Winners and Losers From Higher Short-Term Rates

Howard Simons
  JAN 08, 2014 11:08 AM

If short-term interest rates rise in 2014, the industrial, energy, and technology sectors will reap the benefits.


Anyone who has been around the block in financial markets learns that the obvious trade is seldom the most rewarding. An important caveat, of course, is that contrarian thinking does not produce automatic wins; it simply produces nonstop braggadocio when it works at all. Some form of Darwinism should have eliminated the contrarian gene from our midst by now.
So saying that the obvious trend of expecting short-term interest rates to rise is a compelling one. For starters, the real yield on a two-year Treasury note is -1.25% at the time of this writing; it is maintained there by the combination of a still-accommodative monetary policy and continued risk aversion amongst a large segment of the investing public.
Dial 'T' for Taper

We saw three taper-related jumps in the two-year note’s yield in 2013: one during the May-June first hint, one during the August-September expectation of an announcement, and the third and smallest one in December just prior to the actual announcement of the first tapering. The high in yields of 0.534% in early September would not qualify as much of a high at all in normal times.
The two-year note’s ups and downs did provide us with data as to which industry groups can be expected to out- and underperform the broad market, if and when yields move higher. The first table below lists the S&P 1500 (NYSEARCA:ITOT) industry groups hurt most by rising short-term rates at a 90% confidence level; their weight in the index is multiplied by their relative performance beta to two-year Treasury yields to produce the weighted beta.

Please note the large number of REITs in this table. This is unchanged from August. Utilities do not fare well, either, nor do consumer staple stalwarts in the packaged foods or hypercenters groups; this last one is a fancy term for Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST). The low ranking of the pharmaceuticals group is more of a function of its large weight than of its negative beta.
What about the groups whose relative performance increases when short-term rates rise? Presumably, these are more economically sensitive than those seen in the table above, and they are. They also include a very strong weighting in financial stocks such as Other Diversified Financial Services, home of Bank of America (NYSE:BAC), Citigroup (NYSE:C), and JPMorgan Chase (NYSE:JPM). The industrial, energy, and technology sectors are represented heavily here as well.

The implications are clear: If short-term interest rates rise in 2014 – and even if the contrarians are right, how much can they fall? – you will want to tilt away from allegedly defensive utility, health-care, and consumer staples stocks and toward industrial, energy, and technology issues. Sometimes things can be surprisingly simple if we let them be simple.
No positions in stocks mentioned.