December 11, 2015, The New York Times Online
NEW YORK — It has been so long since the Federal Reserve raised interest rates that U.S. stock market investors probably should not look to past rate hike cycles for clues about potential winners and losers.
But investors do expect more rapid-fire moves from one stock market sector to another, based on what happened throughout 2015 when comments from Janet Yellen or other Fed officials changed expectations of central bank moves multiple times.
Valuations were high coming into the year and Wall Street did not expect much U.S. profit acceleration. So the Fed’s words had more impact, creating sharp rotations in and out of sectors influenced by interest rates. This phenomenon is expected to continue in 2016.
"There is less momentum now behind these sector moves than there has been in the past three or four years," said Brian Reynolds, chief market strategist at New Albion Partners in New York. "In other words you get fast moves without a lot of conviction."
In 2014, the low interest-rate environment boosted groups that paid high dividends, and sectors such as utilities and real estate enjoyed gains of more than 20 percent. Those sectors had it rougher in 2015, with volatility increasing as a possible Fed rate hike started to dominate market discussion.
Utilities, for instance, suffered five straight days of declines in late August. Then, the sector rallied 1.7 percent on Aug. 26 after New York Fed President William Dudley said the prospect of a September rate hike seemed "less compelling."
As expectation for a rate increase grew again, utilities trailed the broader S&P, until the rate hike did not happen. That prompted another rally in the group that lasted until mid-October.
Since that rally, utility stocks weakened as expectations for a December rate hike grew. While the S&P 500 has rallied nearly 9 percent, utilities are down 1.6 percent, the only one of the S&P industry groups to lose ground.
In the past, utilities and real estate were among the better performers in the three months prior to a rate hike and in the year following, according to Michael O’Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.
Financials and autos lost ground after a positive reaction ahead of past rate hikes, he said.
Paul Hickey, co-founder at Bespoke Investment Group, a research firm in Harrison, New York, was wary of sector rotations and advised a cautious approach on a stock-by-stock basis. He said he did see some interest in companies related to the consumer and residential U.S. housing market.
With employment doing well and wages starting to increase modestly, "the consumer is in relatively good standing so we want to focus on areas leveraged to the consumer," said Hickey.
In addition, "Housing is another area where rates are starting to rise but they are at low rates and demographics support housing."
Another surprise could be financial stocks, traditionally strong performers in a rising rate environment as banks can lend at more attractive long-term rates while borrowing at relatively lower short-term rates.
This time around, though, banks must contend with a flatter yield curve, a narrowing spread between long- and short-term rates.
"We think there will selling of banks over the course of 2016," said Peter Cecchini, chief market strategist at Cantor Fitzgerald, who expects the yield curve to flatten.
"With corporate credit secondary market liquidity non-existent and with wage growth absent, bank lending standards are likely to tighten, not loosen," which will also be a headwind, he said.
Pankaj Patel, head of quantitative research at Evercore ISI, said another possibility is that value-oriented sectors such as utilities and financials could benefit once the Fed raises rates and ends the uncertainty that drove much of the market action in 2015.
"We’re all expecting the rate increase, and once the rate is increased, the uncertainty – most of it – will lessen," he said.