– Banks normally benefit from higher rates because it allows them to
increase their spreads – the difference between the interest they pay on
deposits and guaranteed investment certificates (GICs) and the amount they
charge borrowers. This is technically known as net interest margin (NIM).
Insurance companies also normally benefit from higher rates, for slightly
However, this is a broad guideline. Other factors also come into play when
assessing individual companies. For example, some analysts believe Canadian
banks are carrying more mortgage risk than is reflected in the price, and
that has contributed to keeping a lid on share values. Individual banks may
also have specific problems – Scotiabank’s exposure to emerging markets in
Latin America and Asia has weighed on the stock.
So, while it is true that rising interest rates are beneficial to bank
profits, they are not the entire story. You need to look at other aspects
of the business as well.
As for utilities, they have always been considered to be interest sensitive
for two reasons. First, they tend to have high levels of debt because of
the borrowing costs incurred in building corporate infrastructure. Higher
rates translate into more interest expense, which lowers profits.
Second, when rates on safe government bonds rise, investors demand higher
yields from utility stocks because of the extra risk they carry. That tends
to have a downward effect on the share price, which pushes up the yield. A
$1 per year payout on a $30 stock yields a 3.3% return. That may be good
enough in a period of low interest rates. But when bond rates rise,
investors may feel that the same stock must yield 4% to be attractive. That
would push the price down to $25, unless the company hiked the dividend.
Again, there can be exceptions. But the fact the S&P/TSX Capped
Utilities Index was down 12% in 2018 is a clear indication of the influence
of rate increases.
I can’t suggest any sectors apart from banks and insurers that would
normally profit from rate increases. One sector that is likely to be hurt
is homebuilders, as higher rates make mortgages less affordable. Automakers
and parts manufacturers are also vulnerable as rising borrowing costs make
car financing more expensive.
Companies with little or no debt are the least exposed to higher costs.
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