How These 4 ETFs Will Benefit From A Rate Hike

With excellent October jobs data, the interest rates hike for December is back on the table. The U.S. economy added 271,000 jobs in October, much above the market expectation of 180,000 and representing the strongest pace of a one-month jobs gain in 2015. The Fed in its latest FOMC meeting also hinted at a December lift-off if the U.S. economy remains on track.

In a recent Wall Street Journal poll, about 92% of the economists believe that the first interest rate hike in almost a decade will come at the December 15–16 policy meeting, while 5% expect the Fed to wait until March. The rest expect the Fed to keep cheap money flowing for longer.  

This is especially true as recent headwinds have faded with substantial positive developments seen in the global economy and financial market lately. In particular, the Chinese economy is showing signs of stabilization on the back of better-than-expected GDP growth data and another rate cut while the Japanese and European central banks are seeking additional stimulus measures to revive their economies (read: China Investing: Should You Buy These New ETFs?).

Further, the U.S. economy is showing an impressive rebound after a lazy summer and is continuing to outpace the other economies. Though the manufacturing sector expanded at its slowest pace in more than two years in October on a weak global economy and strong dollar, rise in new orders spread some hopes in the sector. Consumer confidence picked up in October, as measured by the Thomson Reuters/University of Michigan index, which rose to 90 after dropping to 87.2 in September from 91.9 in August.

Unemployment dropped to a new seven-year low to 5% in October from 5.1% in September and average hourly wages accelerated by 9 cents to $25.20 bringing the year-over-year increase to 2.5%, the sharpest growth since July 2009. The solid pay gains will increase consumer spending in the crucial holiday season, which will translate into stepped-up economic activities.

Given the recently improving fundamentals, an increase in rates seems justified. As a result, investor should focus on the areas/sectors that will benefit the most in the rising rate environment. Here, we have detailed four of these and their best ETFs below:

Financials

A rising interest rate scenario would be highly profitable for the financial sector. This is because the steepening yield curve would bolster profits for banks, insurance companies and discount brokerage firms. A broad way to play this trend is with Financial Select Sector SPDR Fund (XLF - ETF report), which has a Zacks ETF Rank of 2 or a ‘Buy’ rating with a Medium risk outlook (read: Rate Hike Coming in December? Financial ETFs & Stocks to Buy).

This is by far the most popular financial ETF in the space with AUM of $18.8 billion and an average daily volume of over 37.2 million shares. The fund follows the Financial Select Sector Index, holding 89 stocks in its basket. It is heavily concentrated on the top three firms – Wells Fargo (WFC - Analyst Report), Berkshire Hathaway (BRK-B - Analyst Report) and JPMorgan Chase (JPM - Analyst Report) – with over 8% share each while other firms hold less than 6.2% share. In terms of industrial exposure, banks take the top spot at 37.2% while insurance, REITs, capital markets and diversified financial services make up for double-digit exposure each. The fund charges 14 bps in annual fees and has lost 1.2% in the year-to-date timeframe.

Consumer Discretionary

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Disclosure: None.

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