If the U.S. economy is ripe for steady interest rate hikes, as Fed Chair Janet Yellen says, then several key markets are ripe for changes in 2016.
In a very clear manner, Yellen told investors that a rate hike is not only coming at the Dec. 15-16 meeting but will happen at every gathering that has a press conference next year. To Yellen, or so it seems, as long as the U.S. economy is creating jobs to the tune of over 200,000 a month and there are decent wage gains that spur gradual inflation, the economy could handle higher rates. That is the baseline that investors need to be working from for the time being when selecting investments. Sure, there will be wild day-to-day swings in stock prices, but the core thesis of higher rates looks to have been established until Yellen suggests otherwise.
I think what Yellen and her buds at the Fed are about to orchestrate will have profound implications for every company in business today. With the S&P 500 hovering near its March high, I sense investors still haven't fully grasped the changing fundamental backdrop. Here is where some of the shifts could occur.
Homebuilder stocks: There is a reason why the S&P Homebuilder ETF (XHB) has stayed resilient during the past six months in the face of rising probabilities of rate increases. In fact, to see the ETF hold firm following this week's lackluster pending home sales report was pretty telling of one possibility -- that the specter of higher rates is likely to cause at least one more surge in homebuying activity by people sitting on the fence. They have been sitting on the fence because of no trigger to pull them off the fence -- in their eyes, low rates are the new normal. I suspect that, depending on the weather and economy, the final surge in new home demand will occur in the spring/summer of 2016. As this transpires, I feel as if it will continue to place pressure on the sales results of major apparel retailers such as Macy's (M) as people seek to outfit their homes via trips to Bed Bath & Beyond (BBBY, home goods) and Best Buy (BBY, cheap large-screen TVs).
D.R. Horton (DHI), the largest homebuilder by volume, would be my choice here. The company's average home sells for about $285,000 which is the sweet spot for the fence-sitters. Toll Brothers (TOL) basically sells homes to the wealthy, who care less about higher rates. I would want to play where the buying could be rabid, giving a company such as D.R. Horton the type of pricing power that leads to some nice earnings beats.
M&A market: What a year it has been for the M&A market. From Pfizer (PFE) for Allergan (AGN), to Walgreens (WBA) for Rite-Aid (RAD) to Marriott (MAR) for Starwood (HOT), headline writers at news agencies and investment bankers have feasted on the big deal activity. According to Dealogic, global M&A volume in November totaled a monthly record high of $606.6 billion, up 7% from the previous monthly record of $567.1 billion set in October. So far in 2015, $10 billion-plus deals account for the highest share of global M&A volume on record, says Dealogic. (Pfizer is part of TheStreet's Dividend Stock Advisor portfolio.)
Rates rising may mean two things. First, the bulge bracket firms that have benefited greatly from the boom will earn less as fewer companies pursue costlier acquisitions, and therefore should be approached with greater caution. Consider that Goldman Sachs (GS) topped the global M&A advisor ranking in November with $286.9 billion, followed by JPMorgan (JPM) and Morgan Stanley (MS), with $286.2 billion and $266.2 billion, respectively. These companies are minting money from their deal expertise.
Second, companies with business models that require acquisitions to maintain profits, or boost them, via cost cuts and new lines of business will suffer. I would highlight the packaged-food space, where combinations such as Kraft-Heinz (KHC) at their very core have been fueled by rock-bottom interest rates. In turn, these companies will have to be valued on their own diminishing earnings potential, not the premiums they are fetching today under the premise they will be acquired or acquire someone else. (Allergan, Walgreens, Starwood and Kraft-Heinz are part of TheStreet's Action Alerts PLUS portfolio.)
Regional bank stocks: Ever so quietly, shares of regional banks have come on of late. The SPDR S&P Regional Banking ETF (KRE) has spiked about 11% in the past three months, trouncing the single-digit percentage gains on the S&P 500 and Dow Jones Industrial Average. I agree with the market; the regional banks are the place to be for a couple of reasons, all tied back to rising interest rates. First, regional banks are not feasting on huge M&A deals, which stand to recede in 2016 as rates rise. Second, regional banks are likely to partake a good deal in the last big reach by consumers to buy cheaply funded autos and homes.
I would favor the regional bank ETF here unless you are fully able to grasp the operations of a regional bank.