Talk of 5%+ GDP Growth Sends Rates Surging, Stocks Reeling; But Once the Dust Settles, This Sector Should Prosper!

Rising employment. Rising profitability. Tax cuts. Regulation rollbacks. They’re all combining to give the U.S. economy a big shove in the right direction!

Just look at the news out of the Atlanta Fed, one of several regional Federal Reserve Banks. It’s now projecting that the U.S. economy will grow 5.4% in the first quarter of 2018. More than FIVE PERCENT!

These are only provisional numbers, of course, which means they’re subject to change. The Atlanta Fed’s growth gauge has been “off” by as much as 0.8% in the recent past, thanks to technical sensitivities to manufacturing data.

But wow! Even that would mean Q1 growth of 4.6%, well above the 3.2% long-term average since 1947 ... well above anything we’ve seen recently ... and also well above President Trump’s own campaign promise of 4%. Every percentage point of extra growth can add up to $1 trillion in the size of our economy, so we’re talking about a massive potential boost.

It also would mean that the Federal Reserve, which has been hinting at three rate hikes this year, might already be falling behind. That, in turn, means the Fed might need to play catch-up by raising rates more than previously expected.

In the short term, that’s causing turmoil on Wall Street. The Dow Industrials plunged several hundred points last week due to interest rate fears. Meanwhile, the yield on the 10-year Treasury shot up to 2.8% for the first time since March 2014

But over time, I believe investors will appreciate that a faster rise in interest rates is actually GOOD news for certain stocks – with financials at the top of the list.

Why? When rates are rising, it confirms the economy is growing more quickly. That, in turn, means average Americans are doing better and increasingly able to make their loan payments on time. They’re also likely to borrow more for all kinds of things — new homes, new cars, business ventures, and so on.

Insurance stocks benefit from higher rates, too. It’s easier to cover claims when you have solid income coming in from your huge bond portfolios, even as you’re still collecting premiums. The low bond rates of the past decade have actually been a serious challenge for insurers, so they’re definitely ready for a change.

Believe it or not, there are tentative signs investors are making the distinction. Take a look at the Financial Select Sector SPDR Fund (XLF, Rated “A-”), an exchange-traded fund that holds a broad selection of financial stocks. It was up 7.6% in the last month, much more than the 4.8% return for the SPDR S&P 500 ETF (SPY, Rated “B”). As for the banks-only PowerShares KBW Bank ETF (KBWB, Rated “B+”), it was up more -- 8.9%. Even over the more recent and more volatile 10-day period leading up to last Thursday, these two ETFs rose slightly in value while the S&P 500 declined.

My take: Once the shoot-first-and-ask-questions-later crowd on Wall Street settles down, and starts hunting more actively for “winners” in a rising-rate scenario, financial stocks should prosper. As a result, you may want to scoop up one or more diversified, low-cost ETFs that track the sector.

The best options can be found using the Weiss Ratings Exchange-Traded Fund Screener. I just created a Best Financial Sector ETFs Screener that zeros in on the sub-category of stocks called “Financial Sector Equity.” Then I used the Weiss Ratings slider to put in a floor at “C-”, eliminating any SELL-rated stocks. Of course, you could also pick “B” and higher, or any quality level you like.

Then I screened out stocks with negative returns so far this year. And I included a column showing forward dividend yield so you could get an idea for what kind of income these ETFs spin off. The resulting screen recently looked like this, when sorted in descending order by Weiss Rating:

                                                                       Data Date: 2/2/2018

Among the leaders are the Fidelity MSCI Financials Index ETF (FNCL, Rated “A-”). It tracks the MSCI USA IMI Financials Index by holding at least 80% of the underlying stocks in that index. Top holdings include J.P. Morgan Chase (JPM, Rated “B+”), Bank of America (BAC, Rated “B”), Wells Fargo (WFC, Rated “B”), and Berkshire Hathaway (BRKA, Rated “C”), the holding company run by none other than billionaire investor Warren Buffett. Own this and you own the biggest, broadest selection of financials possible. Of course, the XLF that  I mentioned earlier is another comparable fund under a different ticker, one that’s offered by State Street.

You’ll also find the iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI, Rated “A-”). It’s a fund that focuses on major securities dealers such as Goldman Sachs Group (GS, Rated “B-”), Charles Schwab (SCHW, Rated “B-”), and TD Ameritrade Holding (AMTD, Rated “B-”), as well as big exchanges themselves, such as CME Group (CME, Rated “A”). As the investment environment heats up, these are the companies that are exposed to rapid increases in profitability thanks to more trading and more investment banking demand around the world.

Bottom line: Rising rates can cause turmoil in the short term for the entire market. But until rates rise far enough, fast enough, and for long enough to derail the broader economy, they’re good news for certain industries – with financials at the top of that list!

Think Safety,

Gavin Magor