3 Stocks To Invest In With The Fed Interest Rate HikeJun 28, 2022
Talk about a crazy 1st half of the year. People often overestimate what can be done in a day and underestimate how much can be done in just several months.
And in the last several months alone, we're pretty positive most people underestimated how much could happen that quickly.
To name a few things -- we saw:
Inflation continues to get out of control, while oil & gas prices hit all-time high's
The stock and crypto markets crash
A war raging throughout Eastern Europe
Interest rates finally start rising
And the list goes on...
Unfortunately, the 3rd & 4th quarters are likely to be just as crazy as the first. However, as investors, there are a few things we can do to get prepared for the upcoming events.
And the event we're going to focus on today is the three best ways to invest during a period of rising interest rates.
In case you missed it, rising interest rates have taken center stage for the markets this year. And over the next 12-24 months, rising interest rates will be at the core of whether your investments work or not.
But before we dive into the stocks we like we need to first give some context on why these stocks have a great chance of outperforming in a rising interest rate environment.
As we told you in our guidance for 2022 at the end of last year, rising inflation & rising rates were going to be key themes in 2022 and boy does that look to be beyond true so far.
But fortunately, it's still the early innings and this trade isn't over yet. So in order to figure out how to best play it, we need to open up the history textbooks and see what happened the last time interest rates were set to rise during an inflationary period.
What Happened Last Time:
While no two events are 100% alike, we can use comparables to understand how markets react in similar environments.
And like last time, we saw a few things happen. In 1994 the Fed began aggressively raising rates as they moved up from 3% to 6% in just one year.
And over the course of 2022, we're expecting the Fed to raise at least 6 times on a similar schedule. While we don't anticipate rates to get that high, we do expect them to go from near 0% to the mid-3%'s by the start of next year.
And so with a similar raising rates schedule, we can look back and see that last time this happened financials (at large) did well while banks lagged. The reason this happened was that deposit heavy banks with high variable-rate deposit accounts were subject to serious costs that exceeded the benefits from their loan businesses.
What we mean by this is that most banks offer deposit accounts with either fixed, floating or non-interest bearing accounts. In a rising rate environment, those banks that have a high percentage of their deposit accounts in floating rate accounts will be subject to high costs whereas those with high fixed or non-interest rate accounts will benefit greatly.
The reason they will benefit outside of lower costs is that they will be able to arbitrage the difference between what they pay in deposit accounts and what they can earn on them. Combine that with higher-margin loan accounts and these types of financials can outperform whereas other financial institutions will be at serious risk!
How To Play It:
Therefore when we analyze the financials sector, stock selection becomes more important than ever. If you want to outperform in 2022, investors need to not only get the sector right but they also need to get the stock right and not just pick the index.
Therefore the financial stocks that we like display the following characteristics:
Most of their deposit accounts have fixed rates or are non-interest rate-bearing accounts.
They are a large lender.
And they're positioned to do well over the next 5+ years. The reason this last point is important is because financials often start significantly outperforming in the back half of a rising rate schedule. And because the end of the schedule is impossible to predict, we are allocating now and holding onto names that will be strong into the future.
Top Stocks For Rising Rates:
1) Wells Fargo (WFC) - Low Risk/Lower Reward:
Even though they recently hit our price target we still think WFC has a lot more upside to go. This is due to two main reasons:
As mentioned above, Wells Fargo not only has a high amount of fixed rate accounts, but they also have a very low loan-to-deposit ratio. Low loan-to-deposit ratio's signal low liquidity which is often bad. However in this environment, less cash on hand and higher loan balances is actually very beneficial to their business. With less cash on hand (a liability) and more loans outstanding (an asset) Wells Fargo can position their business to do well over the next 12-24 months.
Wells Fargo is also extremely sensitive towards a rise in interest rates. After analyzing this company more in depth, we see that not only are they sensitive towards this, but they're actually the most sensitive bank in the S&P 500 (except for Silvergate -- which we still like but has a lot more risk associated with it)! With 5+ hikes expected, WFC has the largest risk adjusted upside opportunity of any large cap bank in the US.
Our new price target for Wells Fargo is now $63 and we see them as a strong defensive play with upside return potential and a solid dividend. And even though the stock has sold off as of late, we are waiting for a rebound in the financials sector to come and when it does WFC will stand to benefit.
2) SVB Financial Group (SIVB) - Medium Risk/Medium Return:
SIVB was up nicely since our original recommendation in May but has since dipped given their exposure to the tech industry. However, we're using this time to reiterate our overweight positioning on the stock.
For those of you unaware, SIVB is the go-to bank for many debt lending programs with startups and tech companies. Therefore when tech took a nosedive, SIVB followed suit. And their revenues associated with those companies ending up decreasing by 50% in the 4th quarter of 2021 relative to the 4th quarter in 2020. And while this has bled into Q1, we still fully believe this is oversold.
With many more deals to come across the space, we see SIVB as a nice alternative lender relative to the big banks. And similar to the other stocks on this list, SIVB has a low loan-to-deposit ratio, is a large lender, and is positioned to do well over the next 5+ years.
This pick is assigned medium risk given its exposure to the tech industry. If tech bounces back faster than expected, paired with rising rates, SIVB will be the big winner in the space.
Our price target for SIVB is now $600 and we believe this should occur by Q1 2023!
3) Silvergate Bank (SI) - High Risk/High Return:
Last but not least on our list is Silvergate. Out of any stock on this list, Silvergate is by far the biggest boom or bust pick.
If you're not familiar with Silvergate, they are one of the largest crypto-led banks out of there. This is not your traditional boring finance play. But a lot of their success will hinge on crypto's ability to have a strong 12-24 months. And in case you missed the news, things are about as low as ever. But once stocks rebound, so will crypto and then stocks like Silvergate will surge.
While it may not happen tomorrow (that is the risk), we believe Silvergate is ready to stand benefit to this eventual institutional inflow. And on top of that, Silvergate is the most rate-sensitive bank we cover. This is what they have going for them:
A key theme of this post -- Silvergate's non-interest-bearing deposits represent 99% of their asset accounts. Comparing this to their peers we see that the industry average is near 35%. And as we've mentioned several times now non or fixed interest bearing deposit accounts are key for 2022 and beyond. The reason being is if Silvergate is paying 0 interest on 99% of their deposits, that means their costs are WAY LOWER than any of their competitors.
And not only will they save on costs but their assets will perform very well in a rising interest rate environment too! This is because most of Silvergate's assets are variable rate assets - with rising interest rates, their assets increase more substantially in value.
Therefore we're reiterating our overweight rating and our price target of $110.