U.S. Sector ETFs for a Rising Rate Environment

Investors who are overweight U.S. equity market exposure may want to consider a sector rotation strategy that favors financials and technology sector ETFs in the rising interest rate environment ahead.

According to a recent BlackRock research note, higher interest rates and deregulation could benefit the financials sector while technology stocks have historically been more insulated from yield curve shifts.

“The dispersion of U.S. equity outcomes across yield curve regimes over the last 20 years highlights the importance of rotating sectors over the course of the business cycle,” BlackRock strategists, led by Chris Dhanraj, said in a note.

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“We are overweight U.S. stocks and like cyclicals, specifically financials and technology. We think yield curve steepening will feed bank profitability, and the sector stands to benefit from deregulation. Meanwhile, technology stocks appear most insulated from yield curve shifts, while also being supported by longer-term structural drivers,” the strategists added.

While the yield curve flattened last year due to rising short-term yields due to the growth and inflation outlook, along with Federal Reserve’s rate hike policies, the yield curve has shown signs of steepening or widening with long-term yields rising. Long-term bonds have sold off as markets viewed the tax overhaul plans and prospects of higher government spending as signs of a stronger growth outlook and inflation, signaling an extended bullish environment.

Cyclical Sectors for Rising Rates

Consequently, BlackRock pointed to specific cyclical sector plays ahead, such as financials during a rising rate environment, which boosts bank lending margins. The far-reaching financial sector reforms should also help alleviate some of the restrictions placed following the financial downturn.