Sectors

Key Question: How does each sector perform within each Interest Rate Environment?- Low-High Interest Rate and Regular Yield curve and Inverted Yield Curve (Currently in this Environment).


1. Information Technology – Low

– Performs in Low Interest Environment

Based on the search results, the information technology (IT) sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment.The key points are:

  • Tech stocks are considered “long-duration” assets, meaning their valuations are more sensitive to changes in interest rates. When interest rates rise, the future profits of tech companies appear less valuable, making their stocks less attractive to investors.
  • Rising interest rates make it harder for investors to justify the higher prices of many tech stocks, as they can now get better returns from risk-free assets like Treasuries.
  • The tech-heavy Nasdaq Composite index has dropped significantly in 2022 as the Federal Reserve has raised interest rates to combat inflation.
  • Historically, tech stocks have exhibited a weak positive correlation with interest rates, meaning they have performed slightly better when rates have risen than when they’ve fallen. However, changes in interest rates have explained very little of the variability in tech sector returns.
  • In contrast, sectors like financials, industrials, and consumer stocks tend to benefit more from rising interest rates and a healthy economy.

So in summary, the evidence suggests the information technology sector generally performs better in a low interest rate environment compared to a high interest rate environment


2. Healthcare – High

– Performs in High Interest Environment

The healthcare sector of stocks generally performs better in a high interest rate environment compared to a low interest rate environment.Key points:

  • While high interest rates can pose challenges across sectors, the healthcare sector often remains relatively stable due to the essential nature of its products and services. The demand for healthcare tends to stay resilient during periods of inflation and rising rates.
  • Healthcare companies have inelastic demand – people still need their products regardless of interest rates or inflation. Many healthcare innovations actually see increased demand in high-rate environments as hospitals and companies seek to drive more efficient results.
  • Healthcare is considered a defensive sector, but also an offensive one due to the innovation happening, such as gene sequencing, gene therapy, and mRNA vaccines. This innovation and pricing power allows healthcare companies to generate high returns on invested capital and profitability.
  • Historically, healthcare has been one of the few sectors to outperform both when real interest rates rise and when inflation expectations come down. The sector has demonstrated resilience in past periods of rising rates and economic uncertainty.
  • Healthcare stocks are currently trading at a discount relative to the broader market, suggesting potential upside if the sector continues its recent outperformance in a rising rate environment.

So in summary, the evidence indicates the healthcare sector is well-positioned to outperform in a high interest rate environment compared to a low rate environment, due to the essential and innovative nature of its products and services, pricing power, and resilient demand.


3. Financials – High

– Performs in High Interest Environment

Based on the search results, the financial sector of stocks generally performs better in a high interest rate environment compared to a low interest rate environment.The key points are:

  • The financial sector, which includes banks, investment companies, insurance companies, and other financial institutions, tends to experience increased profitability during periods of high interest rates.
  • This is primarily because banks and other lenders can earn a wider spread between the interest they earn on loans and investments versus the interest they pay on deposits and other liabilities.
  • Higher interest rates also boost the earnings of insurance companies and investment firms, as they often hold large portfolios of interest-sensitive assets.
  • Historically, the financial sector has been among the most sensitive to changes in interest rates, with profit margins expanding as rates climb.
  • A healthy economy with rising rates usually means borrowers have an easier time making loan payments and banks have fewer non-performing assets, further benefiting the financial sector.
  • In contrast, sectors like real estate and utilities can suffer in a high interest rate environment due to their reliance on debt financing.

So in summary, the evidence indicates the financial sector of stocks generally performs better in a high interest rate environment compared to a low interest rate environment.


4. Consumer Discretionary – Low

– Performs in Low Interest Environment

Based on the search results, the consumer discretionary sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment.Key points:

  • The consumer discretionary sector, which includes companies that sell non-essential goods and services, has historically performed well in low-rate environments even when the economy is weak. For example, it was a top performer in the S&P 500 every year from 2008-2015 when rates were near 0%.
  • This is partly because consumers can borrow money at low interest rates to fund purchases they don’t have cash for. Low rates also help consumer discretionary companies have stronger balance sheets, as this sector is the most indebted with a collective debt-to-equity ratio of 739.11%.
  • In contrast, higher interest rates can dampen consumer spending and negatively impact companies in the consumer discretionary sector.
  • Throughout 2022, as the U.S. Federal Reserve raised interest rates, the MSCI World Consumer Discretionary Index fell by 33.36% as markets anticipated a severe impact on consumer discretionary spending.
  • However, those who invested in the consumer discretionary sector coming out of the 2008 financial crisis did well, with the Consumer Discretionary SPDR (XLY) ETF averaging 21.24% annual returns from 2009-2021 without a single losing year.

So in summary, the evidence indicates the consumer discretionary sector generally performs better in a low interest rate environment compared to a high interest rate environment, as higher rates can constrain consumer spending and tighten company balance sheets in this sector.


5. Communication Services – Low

– Performs in Low Interest Environment

Based on the search results, the communication services sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment.The key points are:

  • The communication services sector, which includes companies that provide wired, wireless, satellite, cable, and internet media services, is closely related to the tech sector.
  • Like the tech sector, communication services companies are considered “long-duration” assets, meaning their valuations are more sensitive to changes in interest rates.
  • When interest rates rise, the future profits of communication services companies appear less valuable, making their stocks less attractive to investors.
  • The communication services sector has been one of the fastest growing sectors over the past year, trailing only the broader tech sector, as interest rates remained low.
  • However, the sector has faced some headwinds in 2023 due to factors like antitrust investigations and telecom industry challenges.
  • With the Federal Reserve expected to cut interest rates in 2024, the communication services sector is seen as a lucrative area for investors, as these growth-oriented stocks appear undervalued currently.

So in summary, the evidence indicates the communication services sector generally performs better in a low interest rate environment compared to a high interest rate environment.


6. Industrials – High

– Performs in High Interest Environment

Based on the search results, the industrials sector of stocks generally performs better in a high interest rate environment compared to a low interest rate environment.The key points are:

  • The industrials sector, which includes companies involved in manufacturing, engineering, and infrastructure, tends to outperform the broader market when interest rates are rising.
  • This is because higher interest rates often coincide with a strong economy and increased business investment, which benefits industrial companies.
  • Historically, the industrials sector has started to outperform the market and beat it by around 8% in the year and two years following the end of a recession, when interest rates are typically rising.
  • The industrials sector is seen as well-positioned to benefit from factors like a manufacturing-driven cyclical recovery, normalization of air travel, and increased public and private investment in infrastructure in a rising rate environment.
  • While higher rates can pose challenges for some sectors, the industrials sector’s valuations are currently at a 25% discount to their historical average, suggesting potential upside if the expected recovery materializes.

So in summary, the evidence indicates the industrials sector of stocks generally performs better in a high interest rate environment compared to a low interest rate environment.


7. Consumer Staples – Low

– Performs in Low Interest Environment

Based on the search results, the consumer staples sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment.The key points are:

  • Consumer staples companies, which produce essential goods like food, beverages, and household products, are considered defensive stocks that can perform well even during economic downturns.
  • However, the search results indicate that high inflation and rising interest rates can still negatively impact the consumer staples sector, as it becomes harder for these companies to maintain profit margins.
  • Valuations in the consumer staples sector are seen as too high compared to the elevated interest rate environment and slowing earnings growth rates.
  • In contrast, the consumer staples sector has historically outperformed during low interest rate environments, as lower borrowing costs and improved consumer spending power can benefit these companies.
  • The defensive nature of consumer staples stocks also makes them attractive to investors seeking stability and dividends when interest rates are low.

So in summary, the evidence suggests the consumer staples sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment


8. Energy – High

– Performs in High Interest Environment

Based on the search results, the evidence suggests the energy sector of stocks generally performs better in a high interest rate environment compared to a low interest rate environment.The key points are:

  • While high interest rates can increase the cost of capital for energy companies, the essential nature of their products like oil and gas can maintain demand even in high-rate environments.
  • Energy prices can be influenced by factors beyond just interest rates, such as geopolitical events, supply-demand dynamics, and technological advancements.
  • Historically, the energy sector has been considered a “deep cyclical” sector, meaning it performs very well during times of good economic health when the Fed is raising rates.
  • Merrill Lynch noted that coming off a Fed tightening cycle with rising rates, the energy sector has historically been the best performing sector over a 12-month period.
  • However, the current high debt levels in the energy sector may mean it does not benefit as much from rising rates this time around compared to past cycles.
  • Overall, while high interest rates can pose some challenges for the capital-intensive energy sector, the essential nature of energy products and the sector’s historical performance suggest it generally fares better in a high rate environment compared to a low rate environment.

So in summary, the evidence indicates the energy sector of stocks performs better in a high interest rate environment than a low interest rate environment.


9. Utilities – Low

– Performs in Low Interest Environment

Based on the search results, utility stocks generally perform better in a low interest rate environment compared to a high interest rate environment.The key points are:

  • Utility stocks are considered interest rate sensitive, as rising interest rates can make bonds more attractive to conservative investors who are typically drawn to utility stocks for their stable dividends and low risk profile.
  • Higher interest rates also increase borrowing costs for utilities, which are capital-intensive businesses that rely heavily on debt financing for growth and infrastructure projects. Utilities may not always be able to fully pass these higher costs on to customers.
  • In recent years, the low interest rate environment was an important factor in pushing utility stocks higher, as many investors sought their stable dividends when bond yields were very low.
  • Historically, utility stock indexes have a high negative correlation with interest rates, meaning they tend to underperform when rates rise. However, the relationship is more complicated than a simple inverse correlation.
  • Utility earnings and stock performance are driven more by factors like rate base expansion and authorized returns set by regulators, rather than just interest rates alone.

So in summary, the evidence indicates utility stocks generally perform better in a low interest rate environment compared to a high interest rate environment, as rising rates can make bonds more attractive and increase utilities’ borrowing costs.


10. Real Estate – Low

– Performs in Low Interest Environment

Based on the search results, the evidence suggests that the real estate sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment.The key points are:

  • Rising interest rates can put downward pressure on real estate valuations, as higher rates make the future cash flows of properties appear less valuable.
  • All else equal, a 50 basis point increase in capitalization rates (which tend to move with interest rates) can lead to around an 11% drop in property values.
  • However, the search results indicate that strong net operating income (NOI) growth can help offset the negative impact of higher cap rates on real estate valuations.
  • Properties with high demand, short lease terms, and low operating expenses tend to have the best NOI growth potential in a rising rate environment.
  • Historically, during the last 8 interest rate hike cycles since 1985, cap rates have compressed the same number of times as they have expanded. The only period where core real estate delivered negative returns was during the Global Financial Crisis.
  • Overall, the search results suggest that while rising rates can negatively impact real estate valuations, favorable economic and property-level fundamentals can help mitigate these effects in a low rate environment.

So in summary, the evidence indicates the real estate sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment.


11. Materials – Low

– Performs in Low Interest Environment

Based on the search results, the materials sector of stocks generally performs better in a low interest rate environment compared to a high interest rate environment.The key points are:

  • The materials sector, which includes companies involved in the production and processing of raw materials like chemicals, metals, and construction materials, is considered a cyclical sector that tends to move in sync with the broader economy.
  • In a high interest rate environment, the materials sector can face headwinds, as rising borrowing costs make it more expensive for these capital-intensive companies to finance operations and new projects.
  • Higher interest rates can also dampen demand for materials as the economy slows, putting pressure on profit margins for these companies.
  • Conversely, the materials sector has historically performed better in low interest rate environments, as easier access to capital and stronger economic growth tend to benefit the sector.
  • However, the search results note that even in a rising rate environment, some materials sub-sectors like copper may outperform due to supply constraints, while others like lithium may face more challenges.
  • Overall, the evidence suggests the materials sector generally fares better in a low interest rate environment compared to a high interest rate environment