Research has shown that the correlation between rate increases and stock market returns is positive until the yield on 10-year U.S. Treasuries reaches 5%. It is currently around 2.8%. In Canada, with unemployment at the lowest rates going back to the mid-1970s, it is widely expected that the Bank of Canada will raise its target for the overnight rate to 1.5% on Wednesday. Inflation catching up with the BoC’s target 2% rate, despite high consumer debts and unpredictable housing markets, shows that the economy is moving in the right direction in the context of monetary tightening.

With interest rates expected to increase, investors can position themselves to benefit from this trend.  With interest rates rising, cyclical sectors and financials stand to see a benefit. The two sectors: financials and consumer discretionary have an ability to benefit from rising interest rates. Financials will see a direct impact from rising interest rates, while the Consumer Discretionary will see a benefit from the stronger economic backdrop we see in a rising rate environment.  

FINANCIALS

These stocks benefit from increased lending rates. Their margins are the difference between the rates they borrow at and the rate they charge their customers at, and these margins tend to increase with increasing interest rates.

Industrial Alliance Insur. & Fin. Ser. (IAG)

Industrial Alliance is a Canadian insurance company with a diversified business ranging from wealth management to group pensions with a primary focus on the Canadian market. A 10-basis-point increase in interest rates will impact net income by $15 million.

IAG currently has a dividend yield of 3.01% and is trading at a book value multiple of 1.0 times.  

VersaBank (VB)

VersaBank is a technologically proficient Canadian Schedule I chartered bank headquartered in London, Ontario, and has two primary business activities: the acquisition of deposits and the granting/acquisition of loans. With a growing loan book (~$1.5 billion), a 10-basis-point increase in interest rates will impact net income by $3 million.

VB is trading at a book value multiple of 0.71 times.

(We hold this stock in one of our model portfolios)

Manulife Financial Corporation (MFC)

Manulife Financial is the largest insurer in Canada with $1 trillion in assets under management. With interest rate hikes, one can expect to see an uptick in company results and growth. 

Manulife is currently yielding 3.72% and is trading at 1.08 times its book value. 

CONSUMER DISCRETIONARY

With low unemployment rates and positive economic growth, we see increased consumer spending leading to a surge in top-line and bottom-line numbers of companies in this industry sector. While a higher rate may not in itself support these companies, the signal it comes with (stronger economy, more jobs, rising wages) should support these businesses.

Canadian Tire (CTCa)

Canadian Tire is one of the largest retailers in Canada with stable growth and revenues. It is up 6% year to date and up over 110% over the past five years. CTC imports a majority of its goods and a stronger Canadian dollar from higher rates should make these goods cheaper on a relative basis.

Canada Goose (GOOS)

Canada Goose is a Toronto-based luxury coat maker that saw a recent quarterly profit driven by its own stores and online channel. Despite the retail industry’s struggle, Canada Goose has been to able to perform well due to its reputation for luxury items. The stock is up 98% year-to-date. They are expanding globally and a strong global economy should help support demand for the higher margin products.

Dollarama (DOL)

Dollarama is the largest owner and operator of dollar stores in Canada. The company imports many goods from China. Like with Canadian Tire, rising interest rates could mean a rising Canadian dollar, which impacts its profitability.  

(We hold this stock in one of our model portfolios)  

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