- Rate rises in the US will be gradual but will have the following non-trivial implications:
- Interest rate-insensitive stocks (such as low leverage companies) and banks and insurance companies (whose performance has been positively correlated with Treasury yields in the last 12m) will be favoured by the market.
- Utilities and Energy stocks are out of favour because they have very negative correlation with Treasury yields (worsened by the collapse in energy prices).
- High yield bonds have historically performed well in an environment with rising rates and so are likely to do well (especially now that their implied risk premiums seems to be greater than the calculated default risk and also that the fundamentals of non-energy stocks remain intact).
- Dollar will appreciate against other currencies because monetary policies diverge among the US, EU, Japan and Emerging markets, and also because of the continuing (although slowing down) Quantitative Easing (QE) in the EU and Japan. This could infer the following:
- US exports will be hurt, but with the positive signals from the US labour data, US domestic market might be able to save US companies. The net result is probably neutral.
- Exports to the US will benefit but the net result will vary by country. Europe and Japan are expected to gradually recover partially fuelled by upcoming QE with a low inflation environment. Companies in those regions also have attractive valuations. Emerging markets, however, are expected to underperform further with slow global growth and low productivity, especially when the strengthened dollar is likely to net-net dwarf investors' returns.
- Volatility may continue this year as signals give a mixed picture. In such a market, factor-investing strategies should use low volatility and quality instead of momentum.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.