When Interest Rates Rise, Turn to Bank Stocks

Anyone who has recently received an offer for a credit card balance transfer in the mail over the last few weeks has likely noticed an unpleasant development: a rise in the interest rate to be paid on the loan.

In some cases, the rate has nearly doubled. But, if history is any guide, before this rate hike cycle is over, this convenient personal finance management tool may get even more expensive.

Arguably, if credit card balance transfers are part of your financial plan, you’re probably a bit shell shocked.

The flip side is that you can make the situation work for you.

Here’s a hint. It’s related to the stock market.

It’s All About the Fed

Ever since the Federal Reserve began to trumpet its higher interest rates crusade over the last few months, the stock market has been full of land mines.

And why not? It’s well accepted that rising interest rates are bad news for stock prices.

As a result, certainly with some justification, investors often run for the hills during market periods when rates are about to rise.

Read This Story: Panic Is Not an Investment Strategy

Be that as it may, a contrarian approach would suggest that even during periods of rising rates, there may be some areas of the stock market which can survive and, in some cases, thrive during periods of rising rates.

One of them is the financial sector.

Banks Love Higher Interest Rates

A clear beneficiary of higher interest rates are banks, starting with the money centers such as JPMorgan Chase (NYSE: JPM), all the way down to lesser known regional banks such as Dallas-based Comerica (NYSE: CMA).

The rationale is fairly straight forward. Higher interest rates boost bank profits because rising rates allow them to:

  • Receive higher interest rate payments from their short-term interest rate paying investments such as money market deposits and treasury bills, along with higher dividends from newly issued Treasury and corporate bonds which feature higher paying coupons.
  • Raise fees on credit cards, and
  • Higher rates on car, mortgage, and other loans.

And now that the Fed is all but guaranteeing at least a handful of rate hikes, banks are in the driver’s seat.

One ETF to Bind Them

On the one hand, it’s good to know that the banking sector is a reasonable place to park some money during periods of rising interest rates. Yet, on the other, there are so many bank stocks out there that it becomes difficult to choose, especially when many of them seem to move in tandem.

Therefore, for those who may wish to invest in this sector for the intermediate term (i.e., the next few weeks to months) the Financial Sector SPDR ETF (XLF) may make the most sense.

That’s because in this exchange-traded fund (ETF), you get a good sampling of both bank stocks and brokerage stocks, a combination that offers diversification. This will likely become useful during earnings season where one or two banks, maybe one in which you own shares, could miss on their earnings expectations and the stock could tank.

Thus, by owning the ETF, you can spread the risk around. Moreover, if you don’t like what’s happening and decide to sell, you just have to hit the sell button once.

Bullish Chart During Tough Times

So how good is XLF’s performance at the moment?

Well, even with the recent bounce, the NASDAQ 100 Index (NDX) is down some 9%, while the S&P 500 (SPX) is down nearly 6% after their recent tops.

In contrast, XLF is up slightly for the year, but up nearly 10% since bottoming out late in January. Moreover, XLF has a 1.57% yield, which pays you for being patient if the ETF price goes nowhere. This could be a nice bonus if the stock market as a whole tanks.

But here’s what’s really important. Money is moving into XLF aggressively.

Note the Accumulation Distribution Indicator (ADI) and the On Balance Volume (OBV) lines (lower chart panels).

ADI is a good way to measure whether short sellers are involved in the ETF’s trading pattern. If they were, ADI would be headed lower. And as you can see, ADI just made a new high.

You see a similar picture with OBV, except that OBV is a great way to tell if buyers are moving in. In this case, it’s clear that they are.

And finally, the price in its current range, near the recent highs, tells us that those people buying shares are in no hurry to sell.

Bottom Line

Higher interest rates are usually bad news for many stocks but bank and financial stocks can be a bullish exception during troubled times in the stock market.

By choosing an ETF over individual financial stocks, you get diversification and ease of management when it comes time to sell.

XLF is currently exhibiting positive money flows and what technical analysts call relative strength, meaning that when other areas of the market are weak, financial stocks are in better shape.

If you must own stocks during periods of higher interest rates, it makes sense to consider the financials.

Editor’s Note: Are you still worried about mounting market risks, such as inflation and rising interest rates? To reap profits in good or bad times, consider the trading methodologies of our colleague Jim Fink.

Jim Fink is chief investment strategist of the elite trading services Options For Income, Velocity Trader, and Jim Fink’s Inner Circle.

Jim has agreed to show 150 smart investors how his “paragon” trading system could help them earn 1,000% gains in just 12 months. We’ve put together a new presentation to explain how it works. Click here to watch.