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What Should You Invest In When Interest Rates Rise?

higher int rateStock markets across the globe plunged into a sea of red over fears of a possible increase in interest rates in the U.S. Worries about the Fed easing the stimulus were compounded by signs of weakness in the Chinese economy, and reports that the International Monetary Fund could halt payments to Greece.

Typically, a rising rate environment is a negative for many stocks. Rising rates will lead to higher borrowing costs, material and labor costs which slow down economic growth. But some stocks, especially in the financial sector, tend to thrive in a rising rate scenario.

The trick is to identify the companies that will benefit or be able to survive from rising interest rates. We identify 2 potential sectors below.

Consumer Stocks

Consumer staples (think food, transport) are largely unaffected by interest rates because their target market does not rely on financing to make purchases. Furthermore, if they have pricing power, they can pass on the rising costs to the consumers. These companies also reward shareholders with a healthy dividend yield. Two such companies include BreadTalk (SGX: 5DA) – a bread in the morning keeps you ready for work, and ComfortDelGro (SGX: C52) – the fastest transport when you are late for work!

Financial Institutions/Banks

When you deposit money in the bank, the bank doesn’t just keep it there. Banks make profits by investing or issuing loans at higher interest rates. The difference between what banks earn and what they pay you is called the interest rate spread.

Thus, when interest rates increase, banks will benefit by keeping the savings’ rates low but earn much more from the investments/loans. As a result, their profits will be amplified and leads to higher value of bank stocks. Two banks worth mentioning are Oversea-Chinese Banking Corporation (SGX: O39) – dubbed as the World’s Strongest Bank by Bloomberg Markets 2012 and DBS Group Holdings (SGX: D05) – largest bank in South East Asia.

Foolish Bottom Line

It is unlikely that interest rates will shoot up suddenly, and interest rates is not the only factor to consider when investing. Investors will be wise to exercise caution before ploughing your money into the market without doing due diligence.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.   Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.