Rising borrowing costs are not necessarily a cause for concern as rising interest rates typically go hand in hand with a growing economy, and financial stocks and sector-related exchange traded funds may do especially well in this type of environment.
“When yields experience large changes in short periods of time, stocks can struggle to digest the moves,” Bernstein’s Noah Weisberger said in a note, according to CNBC.
“So long as signs continue to point to a growth-driven move in yields, we think that over the medium term, stocks will fare well,” Weisberger added.
Specifically, Weisberger singled out the financial sector as an area of the market that typically outperforms in a rising rate environment.
“In fact, we would argue that financials — particularly banks — have been held back over the last several months, with scope to catch up to where yields are already,” Weisberger said.
Rising yields in U.S. government debt
The equity markets pulled back Friday on rising yields in U.S. government debt after the jobs report revealed employment numbers and the economy remained strong. Investors were concerned that the easy-money conditions that have helped push U.S. stocks to record highs could come to an end. Nevertheless, the rising borrowing costs does not necessarily mean the good times will immediately end.
“Higher yields tend to be positively correlated both to stock returns and to measures of economic growth, indicative of the direction of causality running from economic outcomes to markets,” Weisberger said.
Consequently, those who still believe in the momentum in U.S. stocks may look to financials to capture a potential area of strength ahead. ETF investors may look to sector-specific plays like the Financial Select Sector SPDR (NYSEArca: XLF), Fidelity MSCI Financials Index ETF (NYSEArca: FNCL), iShares U.S. Financials ETF (NYSEArca: IYF) and Vanguard Financials ETF (NYSEArca: VFH).
Additionally, for more targeted bank specific plays, investors may turn to sub-sector-specific ETFs like the iShares U.S. Regional Banks ETF (NYSEArca: IAT), SPDR S&P Regional Banking ETF (NYSEArca: KRE), PowerShares KBW Regional Bank Portfolio (NYSEArca: KBWR) and SPDR S&P Bank ETF (NYSEArca: KBE).
For more information on the banking sector, visit our financial category.