There are thoughts I’ve been having lately that I haven’t had since I owned bright green bell bottom pants, wore earth shoes, and listened as may parents tried to pick a bank for the next CD by comparing the major appliances they were offering as gifts to consumers who would put their money on ice for a few years for an interest rate of a mere 15% or so. No, I’m not expecting those days to return, but some stock selection techniques from that era may be worth dusting off.

Nostalgic Stock Analysis

Way, way, way back when I started out as an equity analyst, we fussed a lot about the difference between long-term debt and short-term debt. Long-term was good because of the protection it gave to companies from the need to refinance shorter-term obligations at ever escalating interest rates.

We also loved cash and interest income. Talk a about a growing profit stream!

Given that we all seem to have gotten beyond the nonsensical negative-interest-rate notions (which never amounted to anything more than some nominal fees for short-term lending between institutions having reversed direction from the usual borrower-to-lender path; nobody ever believed banks would ever PAY homeowners 5% a year to use the bank’s money to purchase homes) and come to accept the fact that rates have hit bottom, it may now be time to start thinking along the old-fashioned ways.

The question is whether we should start doing that now, or whether we can afford to wait until later, when the sideways trend in in interest rates is finally replaced by a firm and too-obvious-to-ignore uptrend.

An Experiment

I decided to find out by doing a quick experiment on Portfolio123. I built a very simple ranking system that favors companies likely to suffer less or maybe even benefit a bit from rising interest rates. It has only two equally-weighted factors:

• Long Term Debt as a Percent of Total Debt (higher is better)
• Interest Income as a Percent of Pretax Income (higher is better)

I confined myself to the S&P 500 group and eliminated financial stocks (interest income and expense has different meanings in this sector) and screened for stocks that ranked above 50 on a zero to 100 worst-to-best scale. From this rising-rate-friendly group, I created a portfolio by selecting the top 20 as per a standard ranking system I often use based on Quality, Value and Analyst Sentiment.

I then backtested performance on Portfolio123 by assuming I’d rerun the model and refresh the stocks every three months, and by charging each trade slippage in the amount of 0.25% (a proxy for transaction costs).

I compared the performance of that portfolio to a control portfolio, one that selects the top 20 Quality-Value-Sentiment stocks from among the non-financial S&P 500 group without my debt-and-interest income filter.

The Results

Table 1 shows the performance of the rising-rates portfolio and the control portfolio from 1/2/99 (the beginning of the Portfolio123 testing database) until 4/27/15, two years ago, a point in time after which the market had started to contemplate rising interest rates but while many still saw it as a distant phenomenon.

Table 1: 1/2/99 – 4/26/15

The differences are almost non-existent. I think it’s safe to say the allocation of debt between long-term and short term, as well as the importance of interest income on the profit-and-loss statement, meant nothing.

Table 2, however, which focuses on the last two years, when the prospect of rising rates has been a much more respectable topic of conversation, presents a very different picture.

Table 2: 4/26/15 – 4/26/17

Table 3, which hones in on just the last 12 months and includes the Trump rally as a bigger portion of the period, tells the same story as Table 2.

Table 3: 4/26/16 – 4/26/17

This is just a quick back-of-the-envelope type experiment. I just divided stocks in half based on my simple rising-rates rank. I did not (yet) explore the extremes, good or bad, and haven’t (yet) considered whether we’re better off emphasizing those that rank best in terms of amenability to rising rates, as opposed to simply eliminating the worst.

But even this quick sketch tells us something important: It’s time to start thinking about debt-related fundamentals in ways that have been largely irrelevant since I looked good in those green bell bottoms.

The Stocks

Table 4 lists the stocks that currently pass muster under this rising-rate model.

Table 4