Getting Your Portfolio Ready For Rising Rates

by: Glyndon Park


The Fed left little doubt interest rates are sure to rise.

Investors should position portfolios for a rising rate environment.

Several stocks should benefit from rising rates.

The Federal Reserve, and more specifically Janet Yellen, put to rest any doubts about the direction of interest rates. US Treasury purchases are set to decline by another $10 Billion per month with further reductions sure to follow; indications that the Fed will follow a trajectory of short-term rates rising to 1% by the year end 2015.

The impetus of Fed stimulus is undoubtedly aiding a multi-year bull market. As the fed stimulus comes to an end, investors should position their portfolio for a rising rate environment.

Automatic Data Processing (NASDAQ:ADP)

ADP is a payroll processing company with much of their income coming from the float from employers funds before being paid out. Back in 2008, with higher rates, ADP generated $700 million of net income. An amount that is half that level today. As interest rates rise, ADP is sure to see an earnings tailwind boosted by their float income.

ADP by the Numbers

Market Cap (intraday)5: 37.72B
Enterprise Value (Mar 20, 2014)3: 36.09B
Trailing P/E (ttm, intraday): 26.81
Forward P/E (fye Jun 30, 2015)1: 22.37
PEG Ratio (5 yr expected)1: 2.36
Price/Sales (TTM): 3.24
Price/Book (mrq): 6.08
Enterprise Value/Revenue 3: 3.07
Enterprise Value/EBITDA 6: 14.80


Brokerage companies such as E-Trade (NASDAQ:ETFC) and Charles Schwab (NYSE:SCHW) generate income from their loans to investors and customer deposits. With dirt low rates, brokerage interest rate margins have suffered along with their income from client cash balances. We would look for these stocks to benefit handsomely from the increased interest.

Schwab by the Numbers

Market Cap (intraday)5: 35.81B
Enterprise Value (Mar 20, 2014)3: 3.93B
Trailing P/E (ttm, intraday): 35.36
Forward P/E (fye Dec 31, 2015)1: 23.98
PEG Ratio (5 yr expected)1: 1.31
Price/Sales : 6.38
Price/Book (mrq): 3.64
Enterprise Value/Revenue 3: 0.72
Enterprise Value/EBITDA 6:


E-Trade Financial by the Numbers

Market Cap (intraday)5: 7.09B
Enterprise Value (Mar 20, 2014)3: 12.02B
Trailing P/E (ttm, intraday): 85.07
Forward P/E (fye Dec 31, 2015)1: 21.83
PEG Ratio (5 yr expected)1: 0.85
Price/Sales : 4.79
Price/Book (mrq): 1.45
Enterprise Value/Revenue 3: 8.20
Enterprise Value/EBITDA 6: N/A

Floating Rate Fixed Income

Floating rate instruments such as syndicated bank loans stand to benefit as rates increase. The typical syndicated loan's interest rate is set as a fixed spread to a short-term rate such as LIBOR or prime rate. As the rates increase so will the interest payments to investors. Individual investors can access these investments through closed-end funds, we recommend Blackstone's Senior Loan (NYSE:BSL), and ETFs. The leading ETF is Invesco's Bank Loan ETF (NYSEARCA:BKLN).

Select Few Mortgage REITs

One type of Mortgage REIT (mREIT) is especially levered to an upward move in rates -- those specializing in Mortgage Servicing Rights or MSRs. Servicing rights are essentially an annuity stream for the life of the mortgage. They decline in value as rates drop since the mortgage they are tied to is more likely to prepay and the annuity stream will end shortly. As rates rise the opposite holds true and the projected annuity stream grows longer -- increasing the value of the MSRs. Two mREITs that specialize in MSRs are Cherry Hill Mortgage (NYSE:CHMI) and New Residential (NYSE:NRZ). We recommend NRZ over CHMI with a longer operating history spinning off from Fortress.

In conclusion, investors should look to reduce exposure to interest sensitive stocks and add exposure to investments poised to gain from rising rates.

Stock Valuation Data from Yahoo Finance.

Disclosure: I am long BSL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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