Stocks to Buy When Interest Rates Rise

Rising interest rates are typically considered bad news for stock investors. Across the market, stock prices tend to fall whenever rates rise.

However, not all stocks respond equally to rising rates. Some types of stocks actually get a boost from higher rates, while others benefit from the macroeconomic conditions that caused the Federal Reserve to raise rates in the first place. Meanwhile, some types of stocks fall farther than the market as a whole.

We’ll explore what types of stocks investors can buy when interest rates rise.

How Do Rising Interest Rates Affect Stocks?

Across the stock market, rising interest rates typically cause stock prices to fall. Companies face higher borrowing costs, forcing them to cut back on growth. This in turn lowers expectations for their future earnings.

At the same time, companies have to spend more money to service any existing debts with variable interest rates. As companies pay more of their revenue to service debt, their net profits decline.

Rising rates also increase the value of newly issued bonds and treasuries. That results in a flow of money out of the stock market and into bonds, causing stock prices to fall further.

The result of these conditions is that most stock prices decline when interest rates go up.

The Best Stocks to Buy When Interest Rates Rise

Notably, there are some types of companies that benefit from rising interest rates. They may still face higher borrowing and debt costs, but there are other factors at play that cause their stock prices to increase.

Bank Stocks

Bank stocks are among the stocks most likely to gain value when interest rates rise.

The first way in which banks benefit is that they see their interest payments on outstanding loans increase. Higher rates directly translate to more profit on a variable-rate loan, so banks see higher earnings when rates go up. The more variable-rate debts a bank has, the more it can profit.

Another way in which banks benefit from higher rates is that they earn more money on deposits. When rates are low, banks typically earn a small spread between the interest rates they pay depositors and the rates they earn from treasury bills. This is because they want to compete with other banks and credit unions to attract deposits.

However, when interest rates rise, banks have more room to increase this spread. They may keep their rates for depositors the same and hope that depositors won’t leave. Alternatively, they may raise interest rates on deposits by less than the change in treasury bill rates.

Insurance Stocks

Insurance companies also benefit from rising rates because they hold enormous quantities of treasuries and other low-risk bonds. These holdings allow insurance companies to make money from customers’ premiums while also ensuring that they have funds to cover claims.

Some treasuries and bonds that insurance companies hold have variable rates that increase when rate hikes are announced. Even if insurance companies don’t see changes in their return from bonds they already hold, any new bonds they purchase will offer higher interest rates.

Manufacturing Stocks

Rising rates are often a response by the Federal Reserve to a red-hot economy. Raising rates is designed to cool down spending so the economy doesn’t overheat and crash.

There are many types of stocks that can benefit from a strong economy even if there are headwinds from rising rates. In particular, manufacturing stocks can see increased demand for things like home appliances and automobiles if consumers have extra cash and a positive outlook.

However, investors should note that manufacturing stocks don’t all perform well as rates go up. Some manufacturers can see their revenue decline as business customers cut back on growth plans. Investors should primarily consider manufacturers that produce large consumer goods.

Consumer Discretionary Stocks

Another class of stocks that can benefit from consumers having a positive outlook on the economy is consumer discretionary stocks. People may take more vacations, benefiting hotel stocks. They may eat out more, benefiting restaurant stocks. They may even take on a long-awaited home remodel, benefiting hardware company stocks.

However, investors should watch out for consumer discretionary stocks that have large amounts of debt, as we’ll discuss more below. For example, while airlines may see increased revenue as consumer travel picks up, airlines typically also have high debt loads. So, they can end up being hit hard by rising rates.

Stocks to Avoid When Interest Rates Rise

There are also some types of stocks that are likely to be harder hit by rate hikes than the market overall.

Companies with High Debt

Companies with high debt are likely to see their stock prices sink when interest rates increase. These companies will have to pay more in interest on any existing loans or bonds with variable interest rates. That means they make less profit and produce lower earnings. In extreme cases, companies with high debt loads may even have to cut their dividends.

Companies with high debt can be found across all industries. However, they’re especially prevalent in the construction and airline industries, so investors may want to avoid these stocks when interest rates rise.

When evaluating stocks, keep in mind that not all debts get more expensive when rates go up. Only debts with variable interest rates will require higher payments immediately or in the near future.

Growth Stocks

Growth stocks are not directly harmed by rising interest rates in the same way as companies with high debt. However, growth stocks can see their prices plummet when rates increase.

The reason for this is that growth stocks’ high prices are predicated on future growth. When borrowing becomes more expensive, it becomes less likely that these companies will achieve investors’ growth projections. Lowered projections for future earnings result in reduced valuations, causing investors to sell and prices to fall.

Construction and Real Estate Stocks

The markets for housing, commercial real estate, and construction are heavily dependent on debt. When borrowing costs rise, individuals are less likely to buy homes and businesses are less likely to demand new buildings. That deflates demand for both construction and real estate.

Investors should especially steer clear of stocks for homebuilders, as new housing starts typically decline when interest rates increase. REITs that generate most of their income from rentals may weather high interest rates without issue, but REITs that use debt to buy properties are likely to see their prices decline.

Strategies for Investing When Interest Rates Rise

Beyond investing in industries that benefit from rising interest rates, there are two key things investors should keep in mind when rates are going up.

Be Conservative

In general, market volatility goes up and stock performance goes down when interest rates rise. There may be individual companies that see their stocks rise, but on the whole investors should take a conservative approach to the market. Periods of rising rates could be a good time to invest in lower-risk bonds or to accumulate cash to invest in stocks when rates begin to fall.

Avoid Investing around Fed Meetings

There are eight regularly scheduled meetings of the Federal Reserve each year, and announcements about interest rate changes typically follow soon after these meetings. The market is often jittery in the days before and after a Fed meeting when the central bank is in the midst of raising rates.

This volatility can make it more difficult to invest. Stocks might rise after an announcement that rate increases are pausing, only for the mood to sour a day or two later and cause prices to fall again.

Investors can avoid the worst of this volatility simply by avoiding investing around Fed meetings. Investors who do want to buy stocks around these meetings should practice dollar-cost averaging.

Conclusion: Buying Stocks When Interest Rates Rise

Rising interest rates cause most stock prices to fall. However, there are stocks in certain industries, including banking and insurance, that directly benefit from rising rates. In addition, stocks in the manufacturing and consumer discretionary industries can benefit from a hot economy, which is often the root cause of rate increases. Investors should be wary of investing in companies with high debt, growth stocks, or stocks in the construction and real estate industries.