Generally when rates are increased by central banks, the cost of capital goes up. Most companies feel the cost of capital on their balance sheets and their bottom lines come under pressure. If there is already a high inflation environment which the rate hikes are trying to tackle, then commodities, product and services are all getting dearer. This means, the demand would eventually slow down which would bring top line for most companies under pressure.
So, what happens to stocks when interest rates rise? Overall the above issues bring revenues and profits under pressure. Stocks with a low debt to equity ratio generally do well in these conditions due to lower obligations towards payment of interest. These dual issue are why are equities are volatile during this time. But amongst the broader index, there are a few stocks to buy when interest rates rise:
- Financial stocks: Banks, insurance companies and brokerages do well in high interest rate environments.
- Healthcare: Healthcare inflation generally outstrips the CPI index and investing in stocks that have pricing power to pass on this inflation to the customers is a good bet.
- Consumer staples: The consumption story especially in the food and beverages, consumables, alcohol and tobacco area has been compelling as we came out of the pandemic.
