Which are the best stocks for rising interest rates? This is a question many investors are asking themselves as rates climb.
After a spike in early 2021, interest rates seemingly cooled off in the second quarter of this year. But now the threat of rising interest rates is back in earnest, with the yield on the benchmark 10-year U.S. Treasury bond above 1.5% as we enter October – up dramatically from a low of under 1.2% this summer.
A rising interest-rate environment can cause one of those "best of times, worst of times" dilemmas for stock market investors. On one hand, rising interest rates tend to accompany economic expansion that is inherently good for the stock market. People and businesses are spending freely, and as a resul, lenders don't have to incentivize borrowing.
But on the other hand, higher rates means headwinds via more expensive borrowing costs and a general reshuffling of investment portfolios as investors sometimes look at more attractive rates in fixed income markets instead of via equity markets.
However, there are a few stocks that are in unique positions to enjoy the benefits of a booming economy, as well as the tailwind of higher rates.
Here are 10 of the best stocks for rising interest rates. The potential options presented here are for those concerned about mitigating the impact of rising interest rates in late 2021 and into 2022.
Data is as of Sept. 30. Dividend yields represent the trailing 12-month yield, which is a standard measure for equity funds.
- Market value: $10.8 billion
- Dividend yield: 1.8%
Property and casualty insurance company American Financial Group (AFG) is a roughly $10 billion firm that offers protection for trucks, boats, agricultural machinery and other assets. It also offers liability insurance, workers' compensation and other commercial products for small and medium-sized businesses.
Founded in 1872, this Ohio-based company has a long history of crunching the numbers to ensure its core insurance business is profitable for its shareholders.
All well-run insurers fundamentally benefit from the "float" on premiums that clients pay in before a claim is filed and that money has to go out again. In an ideal scenario, not only are these insurance companies paying out less cash in the long-run than they take in, but they are also enjoying a robust flow of cash that they can reinvest in low-risk assets in the meantime.
That's why AFG is on this list of best stocks for rising interest rates. Obviously it would be incredibly risky for an insurer to invest premiums in aggressive strategies, but short-term interest-bearing assets like U.S. Treasury bonds are as good as cash for many CFOs at these firms. So naturally, when rates rise, this idle cash sees a better return to juice financials.
Analysts, on average, are already predicting a nice 12% rise in revenue for American Financial Group next year. And shares have handily outperformed the broader market so far in 2021 with a 44.9% return vs. about 16% for the S&P 500 Index (.SPX) as a whole.
A continued rise in rates could create a financial tailwind for insurance stocks and power AFG even higher.
- Market value: $65.7 billion
- Dividend yield: 0.7%
Ireland-based Aon (AON) is perhaps not the first insurance name you'd think of if you're interested in this subsector of the stock market, but this century-old firm is a great example of how a rising rate environment can create a leg up for certain companies.
As a multinational professional services firm, Aon offers a range of what it calls "financial risk-mitigation products" that include traditional life and health insurance products, as well as pension and retirement services.
As with AFG, the "float" on premiums allow AON to cash in during a rising interest rate environment.
But another angle that makes Aon attractive is that, beyond this benefit, the company also provides services to institutions regarding their defined benefit plans, endowments and other financial vehicles – and if and when rates change, many clients may want to revisit their strategy as a result.
All this adds up to the potential for big tailwinds for AON in late 2021 and 2022. And considering the stock has already risen about 38% for the year-to-date amid anticipation for nearly 10% revenue growth this fiscal year, there's a lot going for Aon right now. The Oracle of Omaha certainly thinks so, with AON added to Warren Buffett's Berkshire Hathaway (BRK/B) portfolio in the first quarter of this year.
- Market value: $9.4 billion
- Dividend yield: 8.1%
Ares Capital (ARCC) a business development company, or BDC. This kind of stock is a bit like a publicly traded company that operates as a private-equity firm, offering investors a way to pool their resources and take advantage of targeted opportunities that ARCC thinks will deliver outsized returns.
Specifically, Ares Capital engages in acquisitions, recapitalizations, restructurings and "rescue financing" of mid-sized companies that typically are between $20 million and $200 million in market value.
In other words, these are Goldilocks companies that are neither too small to be meaningless nor too big to be able to access capital markets in a way that an entrenched blue-chip stock could.
Particularly interesting is the so-called "unitranche" structured investments where Ares goes all-in to be the first and only lender, giving it a powerful seat at the table when it comes to negotiating with management or ensuring its loans are paid in the event of a default.
With a rising interest-rate environment, obviously Ares can command higher returns for the loans it offers mid-sized firms. And ARCC stock has already done quite well lately, including a gain of about 21% for the year-to-date.
Plus, the company offers a best-in-class quarterly dividend of roughly 8.0% after a recent bump to 41 cents a share – sign that this company is dedicated to sharing its success with its public stakeholders.
Adding it all up, it's easy to see why ARCC is one of the best stocks for rising interest rates.
Capital One Financial
- Market value: $74.3 billion
- Dividend yield: 1.4%
Diversified financial firm Capital One Financial (COF) may be best known for its "What's In Your Wallet?" marketing campaign for credit cards. However, this nearly $75 billion stock is much more than that, offering consumer and commercial banking services through roughly 800 branches nationwide.
In fact, thanks to this ever-growing portfolio of loans outside of its credit card business, COF enjoys net interest income of more than $5.5 billion every quarter going back to late 2016!
What's more, its net interest margin – a measure of the difference between interest COF pays out and the interest payments lenders pay back into the company – has been hovering around 6% in 2021. This despite the fact that rates haven't been able to consistently move higher yet this year.
Net interest margin is one of the big tailwinds provided to financial firms in a rising interest-rate environment, as they can gain better returns on their balance of cash while also increasing rates on consumers and businesses that come in for loans.
Capital One's diversified lending portfolio and strong history of success makes this company a prime target for investors looking at the best stocks for rising interest rates.
And considering COF stock is already up nearly 70% in 2021, investors can have confidence that this is a stock with the wind at its back as we close out the year and look ahead to 2022.
Discover Financial Services
- Market value: $38.0 billion
- Dividend yield: 1.6%
Discover Financial Services (DFS) was thought of as an also-ran in the credit-card game by some when it was founded in the 1960s. But the company is now a nearly $40 billion consumer lending powerhouse that stands shoulder to shoulder with peers like Visa (V) and American Express (AXP).
DFS is accepted at nearly 50 million locations, and tallied some $420 billion in payment volumes last year – and continues to grow in 2021 on top of that.
Discover is a natural beneficiary of a rising rate environment as it can also increase the rate it charges for outstanding balances. But it's also good for the growing lending arms at DFS outside of its credit card business. Right now, Discover has about $10 billion in student loans and another $7 billion in personal consumer loans.
With projected revenue expansion of 9% this fiscal year, better margins should help Discover accelerate its growth in 2022 if and when higher rates materialize. That's saying something, considering the stock is already up 40% for the year-to-date.
And after a nearly 14% boost in its quarterly dividend in July, DFS now offers a decent 1.6% yield as a sweetener for those looking at the best stocks for rising interest rates.
- Market value: $31.3 billion
- Dividend yield: 0.6%
Credit data and analytics provider Equifax (EFX) is one of the three national credit bureaus that are effectively gatekeepers on nearly all consumer lending. And in a rising rate environment where loans are going to cost a bit more and consumers are eager to get their scores as high as possible to secure the best deal, EFX is very likely to see an uptick in demand for its services.
Additionally, in the last year or so, EFX has made a series of small but important acquisitions to widen its moat further in the lending and financial services space.
All in all, the firm has notched eight acquisitions for about $3 billion so far in 2021. A few noteworthy deals in this group are background check firm Appriss Insights, banking analytics firm AccountScore and fraud prevention firm Kount.
EFX is already on track to grow revenue at about 17% this fiscal year, and a rising rate environment coupled with these business-building acquisitions should really help out this stock going forward.
Equifax is putting in an impressive showing on the charts this year, too, up about 33% so far – roughly double the S&P 500 in the same period.
Extra Space Storage
- Market value: $23.0 billion
- Dividend yield: 2.9%
Perhaps the quirkiest play on this list of the best stocks for rising interest rates is Extra Space Storage (EXR), a Utah-based real estate investment trust (REIT). This special class of company has to deliver 90% of taxable income back to shareholders in exchange for preferential tax treatment, which means a mandate for big dividends and typically features more conservative capital management as a result.
So why is this a rates play?
Well, with some 1,900 self-storage sites in 40 states – making it one of the largest self-storage management companies in the U.S. – EXR is a massive real estate company. And as anyone who has a mortgage knows, real estate is incredibly sensitive to interest rate trends.
Extra Space increased its debt load significantly over the last few years, finishing 2020 with $5.6 billion in long-term debt, up from $4.8 billion the prior year. However if rates rise, that means this investment was very well-timed, with EXR locking in lower interest rates for the significant real estate holdings of this storage stock.
What's more, unlike some overextended REITs, EXR's total debt load remains comfortable at just over 60% of total assets – so it's not like this company broke the bank here.
If inflationary trends do come to pass, and along with them rising interest rates, EXR will be in the enviable position of having lower rates on its real estate loans but an opportunity to increase storage rates to its clients.
Investors have already shown a lot of enthusiasm for this well-run company, bidding up shares by about 47% so far this year. And a recent 25% increase in its quarterly dividend in August now gives Extra Space a generous 2.9% yield.
If interest rate tailwinds lift margins in 2022, it could be another banner year for this REIT.
- Market value: $181.6 billion
- Dividend yield: 2.7%
An iconic name in asset management, Morgan Stanley (MS) is a great stock to consider for a rising interest-rate environment for a number of reasons. Most obviously, the financial stock has more than $1.1 trillion in total assets under its belt, and a modest rise in rates means it can put idle cash to better use in low-risk bond investments.
It's also important to note that a rising rate environment also will create a bit more volatility in capital markets as Wall Street reshuffles its priorities. That is normally a good thing for elite firms like MS, both because it provides opportunities for its shrewd managers to cash in and because many high-net-worth investors tend to start shopping around for firms like Morgan Stanley that can help them get ahead.
With roughly 9% revenue growth projected this fiscal year, things are already looking up. Plus, after the recent announcement that it would double its dividend and plow $12 billion into a stock repurchase plan, it's clear that MS is committed to sharing its success with shareholders going forward.
And long term, the big-ticket acquisitions of retail trading broker E-Trade Financial and boutique asset manager Eaton Vance continue to give earnings a boost. They have also given this dominant Wall Street firm an even wider moat as it looks to the future, regardless of the rates outlook.
- Market value: $3.2 billion
- Dividend yield: 3.3%
Mainly a provider of student loan services, including federally subsidized loans through the U.S. Department of Education, Navient (NAVI) is a great example of a focused play that could directly benefit from any rising interest-rate environment.
Admittedly, student loans are not the most enjoyable subject – in large part because of the ever-increasing cost of a college education in the U.S., coupled with the vagaries of financial law that means these debts are incredibly difficult to discharge. However, NAVI presents a unique opportunity for investors to profit from this arena, even if you don't agree with them.
To begin with, talk from the White House about plans to write off student loan debt for millions of Americans has ultimately come to nothing – and thus, the core business of NAVI remains unchanged.
Furthermore, Navient is likely to see higher net interest margins in the years ahead amid rising rates. Plus, this student loan stock is boasting a nearly 100% year-to-date return thanks to a better general economic and hiring outlook – meaning families can have confidence the job market will justify a pricey college degree.
While not the most dynamic company, with rather flat top-line performance expected over the next year or two, NAVI does pay a fairly decent 3.3% dividend and continues to accelerate its earnings per share thanks to operational efficiencies.
As such, this is one of the best stocks for rising interest rates, which could help it add to the recent outperformance.
- Market value: $5.5 billion
- Dividend yield: 2.2%
PacWest Bancorp (PACW) is a $5 billion regional bank which operates roughly 70 full-service branches, located mainly in California. This is a real bread-and-butter financial stock, offering various products and services such as auto loans, mortgages, savings accounts and ATMs.
It's not particularly sexy, but this kind of banking activity is the lifeblood of local economies. And as the U.S. economy gets back on its feet, these services are increasingly in demand. Therefore, a rising rate environment will give PACW a further shot in the arm as its net interest margins on car, home and business loans improves in kind.
As proof that PacWest has come roaring back with a vengeance in 2021, consider its earnings per share should finish the year at more than double 2020 levels. And as investors cheer this improvement in the bottom line, they've bid up shares a stunning 170% over the past 12 months.
PACW is now back to its highest levels since 2018 thanks to continued operational improvements. The potential benefits of a rising interest-rate environment could mean new highs for this regional banking stock in 2022.
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