What are we looking for
Picks from U.S. sectors that might benefit from rising interest rates.
The screen
With the U.S. economy reportedly doing well, investors likely feel that the inevitable bump in U.S. interest rates is quickly become a reality. Recall that historically, three sectors in particular benefit from rising interest rates: financials (who benefit with increased lending rates across business lines), consumer discretionary (benefiting from increased consumer spending on positive economic growth) and industrials (benefiting from increased production through higher demand). To find stocks in these three sectors that have shown consistent growth, I've ranked the stocks in the CPMS U.S. database from these sectors on the following:
- Three-year normalized earnings per share, and sales growth rates (these figures measure how much the top and bottom line of a company has grown each year in the past three years);
- Five-year earnings per share (EPS) variability (a statistical measure showing how consistent a firm’s earnings have been over the past five years, lower figures preferred);
- Quarterly earnings momentum (the trailing four quarters of reported earnings compared against the same figure one quarter ago);
- Three-month price momentum (the average price over the past six months as a percentage change from the average price over the six-month period ended three months ago, higher figures preferred)
Today, there are 978 companies within these three sectors in the Morningstar CPMS U.S. database. To qualify, companies must have at least three analysts actively covering the stock. Also, to ensure that companies are not propping up earnings by issuing debt, we require a debt equity ratio that is in line with the sector (in the table, an industry relative debt to equity ratio of 0.9 would imply the company's debt-to-equity ratio is 10 per cent lower than that of the sector).
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used Morningstar CPMS to back test this strategy from December, 1996 to February, 2018. During this process, a maximum of 15 stocks were purchased and equally weighted with a maximum of five stocks a sector. Once a month, stocks were sold if their rank fell below the top 40 per cent of the ranked universe, or if estimates dropped by more than 10 per cent over a three-month period.
When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio.
Over this period, the strategy produced an annualized total return of 12.7 per cent while the S&P 500 Total Return index produced 8.3 per cent.
The stocks that meet our requirements for purchase today are listed in the table. It is recommended you conduct your own independent analysis and speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.