An Unexpected Way To Benefit From Rising U.S. Interest Rates

While we all know that U.S. interest rates have, by and large, been in a downward trend since the early 1980s, over the past few years market participants have begun to think about positioning portfolios for rising interest rates.

As the markets prepare for a transition period in which the U.S. Federal Reserve (Fed) starts to reduce its balance sheet, talk of global accommodation from the European Central Bank (ECB) starts to wane and the U.S. government increases its deficit, we think it is helpful to consider strategies that are tied to interest rate sensitivity, as they can help investors align their equity portfolios with their interest rate viewpoints.

What Strategies Have Been the Best for Rising (or Falling) U.S. Interest Rates?

We chose a period from November 30, 2012, to September 30, 2017, and we utilized a regression analysis in order to see how effective fixed income returns were at explaining the variability of returns across a series of equity strategies. Specifically, our independent or explanatory variables were:

Market Minus Risk-Free Rate: Typically, equity strategies have a sensitivity to movements of the broad market, so we wanted to isolate this factor in order to better zoom in on the sensitivity to shifting interest rates with our other variable.

Interest Rates: Here, we utilized a measure of intermediate-maturity government bond¹ returns such that NEGATIVE coefficients indicate that equities were going up when interest rates were going up (i.e., bond returns were going down) and POSITIVE coefficients indicate that equities are sensitive to falling interest rates, with prices of stocks and bonds moving together. Simply speaking, negatively oriented regression coefficients are leading us toward RISING rate strategies, whereas more positively oriented coefficients are leading us toward FALLING rate strategies.

The Surprise: Japanese Financials Had More Interest Rate Sensitivity than U.S. Financials