The fear of rising interest rates is overblown. In fact, equities have historically been positive to above average, especially after the Federal Reserve resumes its tightening mode. Now is a good time to look at the best exchange-traded funds that can outperform in a period of rising rates.
It is important to keep in mind that the most likely scenario for the foreseeable future is for a slow and steady increase in interest rates.
In this environment, stocks should do well as economic growth continues.
Also, the U.S. Dollar will likely continue its strengthening vs. foreign currencies, such as the euro and yen, which can provide a boost to those export-oriented markets.
Within the U.S., financial stocks can benefit from higher interest rates as banks charge more for lending and brokerage firms enjoy growth from continued market strength. Consumer cyclical stocks can also do well as consumer sentiment (read: consumer buying) remains generally strong.
Based upon these reasonable assumptions, here are three of the best ETFs to buy when interest rates are rising.
Best ETFs After the Rate Hike: Vanguard Financials ETF (VFH)
Expenses: 0.12%, or $12 for every $10,000 invested.
A misconception about rising rates is that financial stocks do poorly. Quite the contrary — financial stocks tend to benefit from rising rates, and Vanguard Financials ETF (VFH) is one of the best ETFs to take advantage of this trend.
Although an increase in the federal funds rate means the rate at which banks can borrow from the Fed is higher, it also means banks can charge higher rates to their customers. Assuming the economy is growing, wages are also growing, and thus the net margins of banks can grow.
VFH seeks to track the MSCI US Investable Market Financials 25/50 Index, which is made up of companies in financial service industries, such as banking, mortgage finance, consumer finance, investment banking, brokerage, insurance and real estate.
Top holdings for VFH include Wells Fargo (WFC), JP Morgan Chase (JPM) and Bank of America (BAC).
Best Funds After the Rate Hike: Consumer Discretionary SPDR ETF (XLY)
Expenses: 0.14%
The early phase of rising interest rates usually coincides with economic growth, when cyclical stock ETFs like Consumer Discretionary SPDR (XLY) can do well.
XLY is a low-cost, highly liquid ETF with a portfolio offering focused exposure to firms largely depend on discretionary consumer spending.
The fund holds a diverse mix of retail firms, restaurants, media companies, apparel and luxury goods companies, automobile manufacturers and leisure firms in the S&P 500.
With eight holdings, the exposure to the top holdings is a bit more concentrated than the average consumer-cyclical fund. Topping the list are Amazon (AMZN), Disney (DIS) and Home Depot (HD).
Best Funds After the Rate Hike: Technology Select Sector SPDR ETF (XLK)
Expenses: 0.14%
Another nod goes to a highly liquid, low-cost State Street SPDR fund on our list of best ETFs with the Technology SPDR ETF (XLK).
Technology stocks tend to outperform the broad market in the mid- to late-phase of the business cycle and the first rate hike coincides with that period.
This sector trend is already evident in this year’s performance for tech stocks, as measured by the XLK’s 0.6% year-to-date gain, which is edging out the 2.6% YTD loss for the S&P 500.
Although XLK is very top-heavy with the top-10 holdings accounting for 60% of the portfolio, they are high-quality U.S. technology stocks, including Apple (AAPL), Microsoft (MSFT) and Facebook (FB).
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities, although he holds XLY for some client accounts. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.
