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10 Funds and Stocks to Profit From Rising Interest Rates in 2020
When the market landscape is changing, you have to adapt to stay ahead . these stocks to buy can help
It’s tough to believe, but the end of 2020 is almost here and the beginning of 2020 is in sight. It’s not too soon to start planning for the coming year, and working to spot the big themes that will dominate the headlines and ultimately drive stocks higher or lower.
And there’s no doubt that one of the coming year’s biggest themes will be rising interest rates. Just a couple months ago, traders were barely betting on a quarter-point hike in the Federal Reserve funds rate. Since then, an uptick in inflation has pushed that projected timeline forward by a full quarter; traders are saying there’s an 87% chance the Fed will take its base interest rate up 25 basis points in December of this year.
And that’s just the beginning. Look for at least one more rate hike next year, if not two. Longer-term, the Fed’s FOMC believes the funds rate will go through six quarter-point hikes before the end of 2020. That’s a big shift, and it’s going to change the market’s landscape.
How? Or more important, what should investors do to make the most of this changing environment? Here are ten of the best funds and stocks to buy to profit from rising interest rates in 2020.
Best Funds and Stocks to Buy: Brokerage Firms
It’s a misnomer that brokerage firms need you to trade frequently to turn a solid profit. They don’t. They don’t even really need you park your money in mutual funds; the residual payouts on funds are rather anemic. As it turns out, brokers can turn a surprisingly tidy profit from their cut on the money market you more or less consider cash.
There are several to choose from, but Charles Schwab Corp (NYSE: SCHW ) has arguably the best of these stocks to buy as it’s the most stable and diversified in the bunch. It’s better positioned than its peers and rivals to cut fees and win market share, and it’s doing just that with a new low-cost index ETF.
Best Funds and Stocks to Buy: Cash Rich Companies
Along those same lines, corporations with lots of idle cash but nowhere to effectively invest it just yet also benefit from higher returns on their money parked in a bank account. Although the upshot isn’t nearly as fruitful as using those funds for, say an acquisition, there’s also little to no risk for slightly higher levels of interest income.
Apple Inc. (NASDAQ: AAPL ) is the poster child for companies that are sitting on more cash than they know what to do with. But, in that most of it is parked overseas and not necessarily bearing the same interest payments its U.S.-domiciled money is, that may not be the ideal way to make such a play. General Electric Company (NYSE: GE ), with its horde of $44 billion — 58% of which is held right here in the United States — is far more likely to see a bit of a margin boost that matters.
Best Funds and Stocks to Buy: Banks
It’s cliche, but worth mentioning all the same. Banks generate significantly more profit when interest rates are higher than when they’re lower.
The mortgage loan you secure with the bank? Contrary to popular belief, the bank doesn’t keep much cash just laying around. It has to borrow the bulk of that money itself before lending it to you. Its borrowing costs rise and fall with interest rates, just like yours do, and its lending profits lie in the difference between the two rates. The higher interest rates are, though, the greater the difference is between your interest rate and the bank’s cost of that capital.
The rising tide lifts all boats in the banking business, but Bank of America Corp (NYSE: BAC ) continues to be one of the standout stocks to buy in the arena. It’s doing everything else right, including cutting costs to the bone.
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Best Funds and Stocks to Buy: Gold
It seems a little counterintuitive. U.S. interest rates tend to move in tandem with the value of the U.S. dollar, and gold is priced in U.S. dollars (moving inversely with the greenback). When rates are on the rise, gold should theoretically be moving lower.
That relationship is a myth though, at least in the long run. In reality, there’s little to no correlation between the two.
There is, however, something of a correlation between gold prices and inflation, and the Fed’s intent in pumping up interest rates is to combat brewing inflation. If the FOMC is right about inflation growth for the next few years — enough so that it’s expecting to put six rate increases in place by 2020 — then gold may be undervalued here. The SPDR Gold Trust (ETF) (NYSEARCA: GLD ) is the easiest means of making a gold play, though it’s hardly the only one.
Best Funds and Stocks to Buy: Rental Real Estate
It’s a loose relationship, to be fair, but it’s a relationship all the same — as the cost of borrowing to buy a home rises, more and more people opt to rent rather than own. That creates fresh demand for apartments and the like, making the rental business more fruitful.
Investors can outright own rental properties, but not all investors will qualify for such loans above and beyond their own mortgages. It’s much easier and far more liquid to simply own residential real estate investment trusts like AvalonBay Communities Inc (NYSE: AVB ) or Mid-America Apartment Communities Inc (NYSE: MAA ).
Best Funds and Stocks to Buy: Treasury Inflation-Protected Securities
Although they’ve been around for quite some time now, many investors still don’t know what Treasury Inflation-Protected Securities, or TIPS, are. Just as the name describes, they’re an investment vehicle — a bond — that is designed to rise and fall with inflation so that you never lose ground to the inflation that tends to accompany rising interest rates. Although investors will likely never “make a killing” with Treasury Inflation-Protected Securities, they’re guaranteed to never lose value either.
There are several ways to buy TIPS directly, but look before you leap. Sometimes you know the yield you’re buying into, and sometimes you just get what you get without knowing your exact coupon. To that end, it may be easier to just step into a Treasury Inflation-Protected Security like the iShares Barclays TIPS Bond Fund (ETF) (NYSEARCA: TIP ).
Best Funds and Stocks to Buy: Business Development Companies
Business development companies, sometimes just called BDCs, are a strange breed. They represent a collection of companies like a traditional mutual fund, but in most cases, rather than equity, they own loans to those cash-hungry organizations that need a helping fiscal hand. That’s why business development companies more or less trade like bonds — the key selling point is the income stream they offer to owners.
Intuitively, it seems that, like bonds, BDCs would lose value when rates are on the rise since their loans are made at fixed rates. That’s not quite how it works though. As is the case with banks, new borrowers are always coming to the table, and like banks, the spread between a BDC’s borrowing costs and its lending rates widen when rates are higher. Some business development companies are even able to borrow at low fixed rates, yet still charge their borrowers the higher, floating rates.
One standout in this space is TCP Capital Corp (NASDAQ: TCPC ), which is a well-known and well-liked business development name.
Best Funds and Stocks to Buy: Short Bonds
Most investors have heard the old adage “when rates go up, bond values go down.” Although the cliche glosses over some critical details of the matter, the underlying premise is still true. That is, rates are set to rise for the foreseeable future and that’s going to work against bonds.
The challenge? You really can’t effectively short bonds, and using bond futures to effectively short bonds isn’t all that accessible for most traders. There is a viable solution though. That is, an ETF that shorts the bond market for you. The ProShares Short 20+ Year Treasury ETF (NYSEARCA: TBF ) is a popular one with plenty of liquidity.
Best Funds and Stocks to Buy: Foreign Companies That Sell to U.S. Customers
Assuming the U.S. dollar does indeed track with the looming rise in interest rates, the increasing value of the greenback means U.S. companies and U.S. consumers will enjoy even more buying power of foreign-made goods and services. The trick is finding an overseas company that sells plenty of those goods to United States buyers.
One often-overlooked possibility to this end is Japan’s Sony Corp (ADR) (NYSE: SNE ). It does a little of everything, but it hasn’t done a whole let very well lately. Still, more than 20% of its revenue comes from the United States. That proportion could ramp up significantly as U.S. buyers’ money goes farther when it comes time to buy a new piece of electronic equipment or U.S. companies need to find some new technological components.
Best Funds and Stocks to Buy: (Some) Dividend Payers
Last but not least, although in some cases a backdrop of rising interest rates treats dividend-paying stocks like bonds and deflates their value, in more than enough cases, rising interest rates facilitates strong growth in an organization’s dividend.
The key is finding a company that’s already in the habit of dividend growth, and won’t balk when the reason for accelerated payout growth arises. Information technology stocks, amazingly enough, do particularly well when rates are on the rise, perhaps because they generally don’t sit on a lot of debt, and enjoy above-average margins that leave them plenty of room for a little better dividend when the market demands it.
One such company is Intel Corporation (NASDAQ: INTC ). Although the dividend yield is only a moderate 2.76%, it has a strong history of growing its payout in step with its growing bottom line. And, though it has been less than the iconic name it once was in recent years, it has a lot working in its favor again right now that makes it one of the top stocks to buy in the environment we’re moving into.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter.
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Long and Short Positions
Long and Short Positions
In the trading of assets, an investor Equity Trader An equity trader is someone who participates in the buying and selling of company shares on the equity market. Similar to someone who would invest in the debt capital markets, an equity trader invests in the equity capital markets and exchanges their money for company stocks instead of bonds. Bank careers are high-paying can take two types of positions: long and short. An investor can either buy an asset (going long), or sell it (going short). Long and short positions are further complicated by the two types of options Stock Option A stock option is a contract between two parties which gives the buyer the right to buy or sell underlying stocks at a predetermined price and within a specified time period. A seller of the stock option is called an option writer, where the seller is paid a premium from the contract purchased by the stock option buyer. , the call and put. An investor may enter into a long put, a long call, a short put, or a short call. Furthermore, an investor can combine long and short positions into complex trading and hedging strategies.
In a long (buy) position, the investor is hoping for the price to rise. An investor in a long position will profit from a rise in price. The typical stock purchase Stock Acquisition In a stock acquisition, the individual shareholder(s) sell their interest in the company to a buyer. With a stock sale, the buyer is assuming ownership of both assets and liabilities – including potential liabilities from past actions of the business. The buyer is merely stepping into the shoes of the previous owner is a long stock asset purchase.
A long call position is one where an investor purchases a call option. Thus, a long call also benefits from a rise in the underlying assets price.
A long put position involves the purchase of a put option. The logic behind the “long” aspect of the put follows the same logic of the long call. A put option rises in value when the underlying asset drops in value. A long put rises in value with a drop in the underlying asset.
Long Position Profits
In a long asset purchase, the potential downside/loss is the purchase price. The upside is unlimited.
In long calls and puts, the potential downsides are more complicated. These are explored further in our options case study Options Case Study – Long Call This options case study demonstrates the complex interactions of options. Both put and call options have different payouts. To study the complex nature and interactions between options and the underlying asset, we present an options case study. .
A short position is the exact opposite of a long position. The investor hopes for and benefits from a drop in the price of the security. Executing or entering a short position is a bit more complicated than purchasing the asset.
In the case of a short stock position, the investor hopes to profit from a drop in the stock price. This is done by borrowing X number of shares Stock What is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms “stock”, “shares”, and “equity” are used interchangeably. of the company from a stockbroker, and then selling the stock at the current market price. The investor then has an open position for X number of shares with the broker, that has to be closed in the future. If the price drops, the investor can purchase X amount of stock shares for less than the total price they sold the same number of shares for earlier. The excess cash Cash Equivalents Cash and cash equivalents are the most liquid of all assets on the balance sheet. Cash equivalents include money market securities, Bankers Acceptances, Treasury bills, commercial paper, and other money market instruments. is her profit.
The concept of short selling is often difficult for many investors to grasp, but it’s actually a relatively simple process. Let’s look at an example that will hopefully help clarify things for you. Assume that stock “A” is currently $50 per share. For one reason or another, you expect the stock price to decline, and so you decide to sell short to profit from the anticipated fall in price. Your short sale would work as follows:
– You put up a margin deposit as collateral for your brokerage firm to loan you 100 shares of the stock, which they already own.
– When you receive the 100 shares loaned to you by your broker, you sell them at the current market price of $50 per share. Now you no longer have any shares of the stock, but you do have the $5,000 in your account that you received from the buyer of your 100 shares ($50 x 100 = $5,000). You are said to be “short” the stock because you owe your broker 100 shares. (Think of it as if you said to someone, “I’m 100 shares short of what I need to pay back my broker.”)
– Now assume that, as you anticipated, the stock’s price begins to fall. A few weeks later, the price of the stock has dropped all the way down to $30 a share. You don’t expect it to go much, if any, lower than that, so you decide to close out your short sale.
– You now buy 100 shares of the stock for $3,000 ($30 x 100 = $3,000). You give those 100 shares of stock to your broker to pay him back for, replace, the 100 shares he loaned you. Having paid back the 100 share loan, you are no longer “short” the stock.
– You have made a $2,000 profit on your short sell trade. You received $5,000 when you sold the 100 shares your broker loaned you, but you were later able to buy 100 shares to pay him back with for only $3,000. Thus, your profit is figured as follows: $5,000 (received) – $3,000 (paid) = $2,000 (profit).
Short stock positions are typically only given to accredited investors, as it requires a great deal of trust between the investor and broker to lend shares to execute the short sale. In fact, even if the short is executed, the investor is usually required to place a margin deposit or collateral with the broker in exchange for the loaned shares.
Other Short Positions
Short call positions are entered into when the investor sells, or “writes”, a call option. A short call position is the counter-party to a long call. The writer will profit from the short call position if the value of the call drops, or the value of the underlying drops.
Short put positions are entered into when the investor writes a put option. The writer will profit from the position if the value of the put drops, or when the value of the underlying exceeds the strike price of the option.
Short positions for other assets can be executed through a derivative known as swaps. A credit default swap, for example, is a contract where the issuer will pay out a sum to the buyer if an underlying asset fails or defaults.
The Bottom Line
There is a wide variety of long and short positions that traders may adopt. A knowledgeable investor will have grasped the many advantages and disadvantages of each individual type of long and short positions before attempting to incorporate using them in his or her trading strategy.
How Stock Futures Work
Futures Contracts 101
When you buy or sell a stock future, you’re not buying or selling a stock certificate. You’re entering into a stock futures contract — an agreement to buy or sell the stock certificate at a fixed price on a certain date. Unlike a traditional stock purchase, you never own the stock, so you’re not entitled to dividends and you’re not invited to stockholders meetings [source: Thachuk]. In traditional stock market investing, you make money only when the price of your stock goes up. With stock market futures, you can make money even when the market goes down.
Here’s how it works. There are two basic positions on stock futures: long and short. The long position agrees to buy the stock when the contract expires. The short position agrees to sell the stock when the contract expires. If you think that the price of your stock will be higher in three months than it is today, you want to go long. If you think the stock price will be lower in three months, then you’ll go short.
Let’s look at an example of going long. It’s January and you enter into a futures contract to purchase 100 shares of IBM stock at $50 a share on April 1. The contract has a price of $5,000. But if the market value of the stock goes up before April 1, you can sell the contract early for a profit. Let’s say the price of IBM stock rises to $52 a share on March 1. If you sell the contract for 100 shares, you’ll fetch a price of $5,200, and make a $200 profit.
The same goes for going short. You enter into a futures contract to sell 100 shares of IBM at $50 a share on April 1 for a total price of $5,000. But then the value of IBM stock drops to $48 a share on March 1. The strategy with going short is to buy the contract back before having to deliver the stock. If you buy the contract back on March 1, then you pay $4,800 for a contract that’s worth $5,000. By predicting that the stock price would go down, you’ve made $200.
What’s interesting about buying or selling futures contracts is that you only pay for a percentage of the price of the contract. This is called buying on margin. A typical margin can be anywhere from 10 to 20 percent of the price of the contract.
Let’s use our IBM example to see how this plays out. If you’re going long, the futures contract says you’ll buy $5,000 worth of IBM stock on April 1. For this contract, you’d pay 20 percent of $5,000, which is $1,000. If the stock price goes up to $52 a share and you sell the contract in March for $5,200, then you make $200, a 20 percent gain on your initial margin investment. Not too shabby.
But things can also go sour. If the stock price actually goes down, and ends up at $48 a share on April 1, then you have to sell the $5,000 contract for $4,800 — a $200 loss. That’s a 20-percent loss on your initial margin investment. If the stock drops considerably, it’s possible to lose more than the price of the initial investment. That’s why stock futures are considered high-risk investments.
When buying on margin, you should also keep in mind that your stockbroker could issue a margin call if the value of your investment falls below a predetermined level called the maintenance level [source: Money.net Inc.]. A margin call means that you have to pay your broker additional money to bring the value of the futures contract up to the maintenance level.
Now let’s look at some of the most common investment strategies using stock futures.
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