The financial markets do not follow rules per se – they bend the rules, twist the rules, buck the rules, and skirt the rules at every opportunity. In fact, causation and correlation are often difficult to come by in the markets. You may believe that the price of gold always rises when stock markets falter, or that equities will take a hit when interest rates rise. What really happens is hardly ever what we expect to happen. The markets are a confluence of interrelated, unrelated, and complicated factors. Common sense economic theory dictates that rising interest rates bode well for bank stocks and financial stocks.
Indeed, these sectors are most likely to benefit when interest rates rise. However, it doesn’t always work out that way. The performance of Citigroup Inc., Wells Fargo & Company, and Bank of America all tell different stories in an era of rising interest rates. Why is that? Is it the individual performance of each banking institution that determines whether interest rates will affect the bottom line? Or is it perhaps something less obvious such as the ongoing scandals at Wells Fargo & Company?
As a rule, it is safe to say that the correlation between interest rates and the performance of financial stocks is positive. In other words, when rates rise, stock prices should move in unison. When interest rates fall, banks stand to lose money since the spread is lower and the profits that they can make from lending money are less. Then there’s the lag effect to contemplate in the financial markets. Nothing ever happens instantaneously – many decisions have been brewing for quite some time, allowing stakeholders in the markets to price them in to market fundamentals.
How is Bank Of America Performing?
We see evidence of this everywhere. Bank of America is trading above $32 per share and is prospering even though its performance is tapering out. Wells Fargo and Company is not doing as well, owing to the millions of fake accounts that were created and the damage to the company’s credibility that has resulted. This begs the question: How can you really use market news, insights, and analysis to make an educated decision about direction of movement? It appears that traditional economic theory holds true on the proviso that nothing upsets the applecart.
We can forecast that multiple rate hikes will have a positive effect on financial stocks over time. The impact of higher interest rates on listed companies on the NYSE, Dow Jones, NASDAQ composite index, and others is likely to be negative over time. As these companies pay more money in interest to the banks and financial institutions – so their profitability gets eroded a little bit more. But there’s another parallel track in play – rising interest rates erode the personal disposable incomes of US households. When there is less money to go around, listed companies suffer. This also leads to reduced sales, lower profits, and falling stock prices.
Experts Weigh In
Olsson Capital trading specialist, Blake Bellwether Sr believes that a balanced portfolio needs to be dynamic, diversified, and detailed:
‘For many of us, our risk preference – risk-averse or risk seeking – will determine the types of stocks we pick and the revenues that result. Risk-averse individuals tend to be satisfied with single digit returns over time. Risk seeking individuals will invest in a stock-heavy portfolio with greater focus on technology stocks, biotech, pharmaceutical, and other innovative technologies.
Perhaps the best approach to adopt is one which fuses growth and stability, risk and risk aversion, in a way that allows for maximum gain. It’s a tough balancing act to adopt, but one which is necessary in a dynamic and ever-evolving economic landscape. One must be an acrobat, a savant, and a thick-skinned stakeholder to succeed in today’s marketplace. Traditional financial instruments are linear – they appreciate, and you benefit. Non-traditional financial assets such as derivatives trading and futures contracts can profit in any direction – provided you call it right.
Gold, the Japanese Yen, and CFD trading are examples of ways to guard against stock market volatility. The performance of markets is peppered with checks and balances. The more you invest in shares, the greater your exposure to geopolitical volatility. Gold, cash holdings, bonds and the like are safe up to a point. Your financial portfolio should be balanced to reflect your risk profile. As a risk seeker, you would hold more equities than gold commodities, and vice versa. Sometimes you can use your derivatives instruments and gold holdings to hedge against volatility in stocks you hold of those same financial instruments!’