Inflation has suddenly become the Federal Reserve’s most pressing problem. For years, the Fed had been focused on boosting employment and avoiding deflation, and there’s been no need for rate hikes. Since Covid-19, however, the tables have turned. Headline inflation recently hit 7% annually, which is its highest level in decades.
The Fed now appears intent on raising interest rates aggressively to fight off this rising inflationary wave. Short-term interest rates have surged over the past few months, as the market starts to bet on at least four rate hikes this year. Some Wall Street strategists are saying we could get as many as eight hikes by the end of 2023.
Needless to say, this would have a dramatic effect on the stock market. Some sectors, such as technology, fare poorly in a rising interest rate world. Indeed, tech stocks have already gone into a slump since November when the interest rate surge began in earnest. However, there are companies that actually benefit from rising rates. These seven best stocks should protect your portfolio regardless of how many rate hikes the Fed engages in over the next year:
- Charles Schwab (NYSE:SCHW)
- Exxon Mobil (NYSE:XOM)
- Public Storage (NYSE:PSA)
- American Tower (NYSE:AMT)
- Hershey (NYSE:HSY)
- MVB Financial (NASDAQ:MVBF)
- Prudential Financial (NYSE:PRU)
Stocks to Protect from Rate Hikes: Charles Schwab (SCHW)
Charles Schwab is the quintessential rising interest rates stock. If you’re not familiar with the brokerage business, this might come as a surprise. However, the business model has dramatic leverage to interest rates.
As you probably know, commissions on most stock trades have dropped to tiny amounts, or even free in many instances. So brokerages have to rely on other sources of income.
One of these big ones can be interest on customer deposits. Typically, customers don’t expect to receive much — if any — interest on their deposits. People don’t put money in a brokerage account to collect interest on cash, after all, but rather to buy stocks and other financial assets.
But that cash is valuable. Schwab can put customer cash in safe assets such as short-term government bonds and keep the earned interest for itself. In normal times, that’s a major profit center. When interest rates are at zero, however, Schwab earns minimal interest on these deposits. If and when interest rates surge, however, this profit center will turn itself on in a major way, powering SCHW stock much higher.
Exxon Mobil (XOM)
At first, it may seem counterintuitive to buy a cyclical stock such as Exxon Mobil in a rising interest rate environment. After all, if the Fed hikes five or more times, that is likely to slow down the economy and hurt demand for oil and gas. That’s all well and true.
But think about why the Fed is having to hike so much. It’s primarily due to out-of-control inflation, with oil being at the center of that. Oil, thus, is a sort of fulcrum asset.
If inflation keeps soaring, investors will make plenty of money on the way up owning energy names such as XOM stock. If we get to five hikes or more, it’s probably because the price of crude oil topped $100 per barrel. And if inflation peters out and the Fed reduces its rate hiking ambitions, that’s also good for energy because it means that demand for the product is likely to remain elevated. Thus, the energy sector is a win-win here.
Exxon Mobil is particularly attractive since it has a low cost structure and very little debt proportionate to its balance sheet. As one of the least-leveraged major oil producers, Exxon Mobil can easily withstand higher interest rates. Meanwhile, competitors with less healthy balance sheets might see their interest costs soar as a proportion of their overall net income statement. As long as inflation is the main problem, energy should outperform and stable low-cost producers like Exxon Mobil will particularly benefit.
Stocks to Protect from Rate Hikes: Public Storage (PSA)
Real estate investment trusts (REITs) are historically another asset that tend to fare well during times of inflation. This makes sense. REITs, after all, primarily own land and the buildings that sit on top of it. These are naturally inflation-resistant assets; houses, offices, and so on tend to soar during periods of monetary stimulus.
Within REITs, however, it pays to use discretion. Some types fare better than others. It’s useful to look at both the type of tenant at a property, and also the REIT’s debt structure.
In Public Storage, we have a winner on both counts. Self-storage is a great asset for inflation. That’s because most contracts are structured on a month-to-month basis. Public Storage can easily raise prices if and when it wants to do so. That’s in sharp contrast to something like offices, where most contracts tend to be many years in length, thus causing a delay between when inflation occurs and when the landlord can raise the rent.
Also, given that storage is a low-touch asset, it shouldn’t be hit by operating cost increases too much. The average storage facility only needs a couple of employees, making it more resistant to labor cost inflation than something like hotels or malls.
Finally, Public Storage specifically has a fantastic debt structure. It funds itself with a ton of preferred stock issuance. Preferred shares pay a modest interest rate, around 4% annually on average for Public Storage. And these debts never mature. Public Storage can elect to pay 4% annually indefinitely and never redeem this debt. If inflation soars, Public Storage’s liabilities would greatly diminish in value, all while the value of its land and storage facilities soars. PSA stock is a great inflation-proof asset on multiple fronts.
American Tower (AMT)
American Tower is a specialty REIT. Specifically, it focuses on owning and operating the towers that provide connectivity services for telecom carriers.
The rise of smartphones and newer trends such as the Internet of Things and connected devices has led to increasing demand for mobile data. American Tower isn’t just active in the U.S., either. It has a huge operation in emerging markets where there is still more room for new cell phone tower development.
The business has an attractive inflation-proof model. In general, its average lease automatically escalates around 3%/year. That might not sound like that much during a period of high inflation. However, American Tower has very low operating costs, so inflation doesn’t hurt it much. AMT stock has been a tremendous winner over the years, and it is well-positioned for the switch to a higher interest rate environment.
Stocks to Protect from Rate Hikes: Hershey (HSY)
Hershey is one of the best businesses out there for dealing with a high interest rate environment. In the United States, chocolate is an oligopoly business. Hershey, Mars and a just a couple of other players control nearly all of the market. As such, they can easily raise prices during inflationary periods, such as the current one. Additionally, people’s preferences are pretty fixed in terms of how chocolate tastes; most people won’t switch brands to save a few cents.
On the balance sheet side of the equation, Hershey has a fair bit of fixed debt, which will decline in significance as inflation takes hold. And what makes Hershey really special is the tiny amount of capital it needs to run its business.
The company has just $2.6 billion in property, plant and equipment against its $42 billion market capitalization. In English, this means Hershey has to invest very little in its factories to produce all its chocolate and snack foods.
This sort of capital light strategy insulates Hershey from rising interest rates. Warren Buffett always speaks favorably about capital-light businesses with strong brands as it relates to having wide inflation-proof moats. Hershey is as good an example of this sort of business as you could hope to find.
MVB Financial (MVBF)
MVB is an under-the-radar regional bank hailing from West Virginia. While it has so far escaped Wall Street’s notice, MVB has shown tremendous growth in recent years. That’s because the bank has become a leader in offering services for emerging industries, such as online gaming and cryptocurrencies.
Right now, most banks are afraid to deal with these sorts of companies. There are much higher compliance hurdles in terms of banking a gaming or crypto client as opposed to traditional commercial accounts. However, MVB has invested heavily in internal programs and acquisitions to get its legal and compliance department up to speed.
As a result, it has dominant market share in the gaming space in particular; it is the bank for the majority of American online gaming websites. As customers sign up and fund their accounts at MVB-affiliated sites such as DraftKings (NASDAQ:DKNG), MVB gets to handle those new accounts. MVB has become one of the nation’s twenty-largest banks by number of customer accounts thanks to the boom in online gaming and cryptocurrency.
Here’s where things get fun from a rate hike angle. Almost all these new accounts don’t have to pay interest. People open an account at DraftKings to bet on the big game, after all, rather than to collect interest. MVB doesn’t have to pay competitive interest rates to keep depositors there, since the appeal of the account is from other services.
Add it up, and MVB should enjoy massive net interest margin expansion as interest rates soar. It can lend money at higher rates, while paying depositors very low average rates. MVBF stock still trades for less than 20x earnings, even after doubling its earnings per share recently. And the interest rate benefit is just now starting to kick in, adding more leverage to its growth story.
Stocks to Protect from Rate Hikes: Prudential Financial (PRU)
Prudential is a life insurance company, and another great asset in a rising interest rate environment. That’s because insurers live off the returns on their investments.
A life insurer generally doesn’t make much money on actual policy underwriting. Over time, policyholders get back almost all of what they put into the plan, on average. No, insurers make money because they get to invest the premiums on those insurance policies for decades in between when the policy is purchased and when the policyholder passes away.
In a normal world, insurers can make a lot of money buying simple fixed income products with that premium. In recent years, however, yields on safe bond assets have dropped precipitously, making life much more difficult for insurers. This may be coming to an end. As interest rates potentially rise significantly, insurers like Prudential will be able to lock in much higher returns on their investment portfolios.
As things stand today, PRU stock is already highly attractive. Shares trade for just 9 times forward earnings. In addition, the stock is selling at a significant discount to book value, which is a key metric in the insurance space. That’s not all. The stock also offers a juicy 4% dividend yield.
On the date of publication, Ian Bezek held a long position in MVBF, XOM, PSA and HSY stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.