Why a Coming Surge in Interest Rates Is 2017’s Biggest Investment Story

Investors need to be aware of the big picture for their portfolios and invest accordingly. For 2017, this means rising interest rates. Investors should profit by holding cyclical names such as Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK) and Baytex Energy Corp. (TSX:BTE)(NYSE:BTE).

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

By ignoring the big economic picture, investors do so at their own peril. In 2014 and 2015, for example, many commodity-based companies may have looked fantastic individually, but ignoring the broader economic picture that resulted in a historic commodity rout cost many investors massive returns.

Similarly, in 2016 investors who caught on to the big-picture story of commodity prices being way too low to encourage enough production growth to meet steady demand (especially after nearly two years of underinvestment across the commodity complex) would have seen fantastic returns in 2016.

What is the big narrative for 2017? One of them will be rising interest rates. The main catalyst for rising interest rates has been the election of Donald Trump. Some, like billionaire Stan Druckenmiller, see this as being one of the only reasons. Trump is set to unleash a series of pro-growth economic policies, including widespread deregulation, a cut of corporate taxes from 35% to 15%, personal income tax cuts, the repatriation of overseas corporate profits, and a $1 trillion infrastructure plan.

The result of these policies will be economic growth, and economic growth leads to increased inflation and interest rates. Druckenmiller sees the 10-year U.S. bond yield eventually surging to 6% (it is currently 2.44%–the highest level since July 2015 and up from 1.8% pre-election).

This has massive implications for stocks, some of which are positive and some of which are negative.

How rising rates affects your portfolio

Since Trump’s election, interest rates have been rising and stocks have been rallying. For the first part of 2017, this pattern is likely to continue. A recent report by Goldman Sachs indicated that when bond yields are low (especially under 3%), rising bond yields are actually associated with rising stock prices.

What kind of stocks perform well in this environment? Cyclical stocks in particular (these include energy stocks, industrial stocks, and materials stocks) perform well. This is in contrast to defensive stocks (like utilities, which typically perform well regardless of the point in the economic cycle).

A recent report found that during the previous seven Federal Reserve rate-tightening cycles (periods of rising interest rates), energy stocks returned an average of eight percentage points more than the index, and materials beat the index by six percentage points. Defensive sectors underperformed.

Since rising rates are typically indicative of a strong economy, investors should be overweight in cyclical stocks that are in the energy or materials spaces, as these sectors will likely outperform.

Unfortunately, however, the effect of rising interest rates is not all positive. The same Goldman Sachs report stated that when interest rates rise close to the 3% level, rising interest rates are associated with falling equity prices. The current stock market is overvalued by historical standards, but this overvaluation is justified by interest rates being low (low bond yields send investors to stocks for yield). When interest rates normalize, this is bad news for stocks.

Goldman Sachs sees 10-year U.S. bond yields of 2.75% as the point in which stocks become overvalued, and a 10% correction would result if yields hit 3%. With this in mind, investors should also keep more cash in hand into 2017 to use any correction as an opportunity to add to more cyclical names.

What should Canadian investors buy?

While this has mostly focused on U.S. yields, Canadian yields typically track U.S. yields fairly closely, and what happens in the U.S. closely effects Canada. A diversified portfolio to take advantage of rising rates would include Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK) and Baytex Energy Corp. (TSX:BTE)(NYSE:BTE).

Teck gives investors exposure to metallurgical or steel-making coal, copper, and zinc. These commodities have performed well this year and will continue to do so on strong Chinese economic data (the main users of these commodities), as well as tightening supplies.

Baytex gives investors leveraged exposure to rising oil prices. Baytex has a relatively high debt load and produces heavy oil; both these factors mean that Baytex will rise significantly more than its peers per dollar increase in oil prices.

Should you invest $1,000 in First Capital Real Estate Investment Trust right now?

Before you buy stock in First Capital Real Estate Investment Trust, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and First Capital Real Estate Investment Trust wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $20,697.16!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 29 percentage points since 2013*.

See the Top Stocks * Returns as of 3/20/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Mancini has no position in any stocks mentioned.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Energy Stocks

Oil industry worker works in oilfield
Energy Stocks

CNQ Stock: Buy, Hold, or Sell Now?

CNRL is down 35% in the past year. Is CNQ stock now oversold?

Read more »

Canadian dollars in a magnifying glass
Dividend Stocks

Young Investors: How I’d Allocate $10,000 for Long-Term Potential

Young Canadians can achieve financial independence faster by saving and investing early.

Read more »

canadian energy oil
Energy Stocks

How I’d Position $7,000 in This Canadian Energy Stock for 2025 Growth Potential

Tourmaline, Canada's low-cost and largest natural gas producer, is benefiting from strong industry fundamentals.

Read more »

nuclear power plant
Energy Stocks

1 Magnificent Canadian Stock Down 40% to Buy and Hold Forever

This energy stock may be down, but do not count it out if you're looking for long-term income.

Read more »

A plant grows from coins.
Energy Stocks

Where I’d Put $15,000 in Top Energy Stocks for Income and Appreciation

The recent pullback in energy stocks presents a compelling opportunity for long-term investors to generate capital gains and dividend income.

Read more »

A worker overlooks an oil refinery plant.
Energy Stocks

Top Energy Stocks to Invest in for 2025

Energy stocks are a solid choice for investors, but these could be the best option in 2025.

Read more »

Utility, wind power
Energy Stocks

Here’s How Many Shares of Northland Power Stock You Should Own to Get $5,000 in Annual Dividends

Looking for monthly income for now and the future? Consider this a top option.

Read more »

Investor wonders if it's safe to buy stocks now
Energy Stocks

Billionaires Might Sell U.S. Stocks and Buy This Canadian Stock to Avoid Tariff Risks

Billionaires might be worried about the future of U.S. stocks with the markets the way they are, and looking for…

Read more »