The world's biggest interest rate party is rapidly winding down as central bankers from around the globe have removed the punch bowl – or at least the alcohol – from the dance hall. Record low interest rates and several bouts of quantitative easing have left several major stock indices dancing near record or multi-year highs, and this includes our S&P/ASX 200 (Index:^AXJO) (ASX: XJO).
The US and Canada have already started lifting rates off record lows and other central bankers like those from the UK and EU have made hawkish comments about following suit. The Reserve Bank of Australia seems to be in no rush to hike but just about every economist believes the next move it makes will be up.
The threat of higher interest rates leaves equities vulnerable to a pullback. Rising cost of debt will slow business growth and increase the discount rate that analysts use to value stocks.
However, a higher interest rate environment probably won't bring this bull market to an end. After all, rising interest rates are a direct response to the improving global economic outlook and that should be more than enough to offset the brakes rising rates are putting on stock valuations.
On the other hand, some stocks are better placed to thrive as credit conditions tighten, while others are set to lag. Deutsche Bank warns that "yield stocks" are likely to suffer further – especially infrastructure and utilities that have rallied to record highs over the past month.
The broker didn't name names, but I can't help but think of airport operator Sydney Airport Holdings Ltd (ASX: SYD) and energy infrastructure business AusNet Services (ASX: AST).
Deutsche also believes that "value stocks" will outperform "growth stocks" as higher discount rates tend to hurt growth stocks more and stocks that trade at attractive valuations often perform better as rates start rising. Growth stocks refer to companies that are forecast to deliver profit growth rates that are in excess of the wider market, while value stocks are those that trade at a discount to their peer groups (e.g. a lower price-earnings multiple).
On that basis, the broker is recommending investors buy electrical and furniture retailer Harvey Norman Holdings Limited (ASX: HVN), insurer QBE Insurance Group Ltd (ASX: QBE), property group Stockland Corporation Ltd (ASX: SGP), fertiliser supplier Incitec Pivot Ltd (ASX: IPL) and two of the Big Four banks – National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC).
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