A Rate Hike Is Back on the Table and Your Portfolio May Need Adjusting

Investors felt a bit of a shock on Monday of this week when the Federal Reserve issued several statements indicating that a rate hike was seemingly back on the table as early as next month. Boston Federal Reserve’s President Eric Rosengren and member of the FOMC (Federal Open Market Committee) indicated that a rate hike could be needed as soon as June amidst a tightening labor market. Fear of pent-up inflation was the major concern that caused the Fed to suddenly reverse direction.

The abrupt near-term possibility of higher interest rates sent investors scrambling for some kind of direction but the broader indexes ended Monday on a flat note. However, higher rates could be a good sign for an economy that has struggled to put up any kind of data that investors could get behind—bullish or bearish. Considering how apathetic the markets have been this year, investors haven’t set up their portfolios to take advantage of the shift in expectations.

An interest rate hike wasn’t expected until at least December of this year so the news that a rate could happen as early as June means most investors aren’t prepared for how the market should react. Higher interest rates should cause a bump in yields, which makes dividend stocks slightly more expensive to own.

But while the rate hike is bad news for defensive dividend paying stocks, it’s good news for sectors that thrive on higher rates.

The financial sector usually benefits the most from rising rates. Higher rates equals higher margins for banking and insurance stocks which are able to invest at higher rates of return and charge more for their products since most are based off of the 10-year treasury yield. Banks earn more from the spread between long term debt and short term debt.

Schwab Financial Services Fund (SWFFX) is a good pick up for rising rates. It contains a diverse set of financial and insurance assets, and comes with an expense ratio of 0.93—well below most sector-specific mutual funds. If rates do go up, look for this fund to take full advantage of the financial industry.

Higher interest rates are often precursors to higher consumer spending as a healthy labor market brings the economy to full employment with employee pay generally seeing a rise as well. More spending translates into more profits from consumer discretionary goods such as food, autos, clothes, hotels, and many other items.

One mutual fund that’s been consistently rated as one of the top consumer discretionary plays is Fidelity’s Select Consumer Discretionary Portfolio (FSCPX). It comes with a low 0.77 expense ratio and holds a wide selection of stocks in the consumer discretionary space. It’s been putting up healthy gains over the past few years as well with a 3-year and 5-year return of 12.50% and 13.10%, respectively.

If the Fed does raise rates next month, the issue will become at what pace will rates continue to rise. Will another cut be on the horizon for December or will that one be pushed back until 2017? Either way, the Fed will need to address the issue quickly once the decision to raise rates is made—or risk letting uncertainty take hold in the marketplace.