Warning: Rising Interest Rates Will Put Pressure on These Stocks

Rising interest rates could curb growth at Home Capital Group Inc. (TSX:HCG) and AutoCanada Inc. (TSX:ACQ) in late 2018 and beyond.

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On October 24, the Bank of Canada elected to raise the benchmark interest rate by 25 basis points to 1.75%. This decision also happened to coincide with the largest single-day drop on the TSX in three years. Many analysts and economists have blamed anxiety over rising rates for the global stock market pullback.

The central bank has committed to its gradual path, as Canadian consumers adapt to this rate-tightening environment. Canada possesses one of the highest debt-to-income ratios in the developed world, and recent rate hikes have already put the squeeze on many who are carrying large debt loads. An Ipsos survey conducted in October saw 45% of respondents state that higher interest rates were impacting their budgets. Another 52% of respondents said they were concerned about making their debt payments.

Today, we are going to look at two stocks that may face downward pressure due to higher interest rates. Should investors steer clear going forward? Let’s dive in.

Home Capital Group (TSX:HCG)

Home Capital Group is a Toronto-based alternative lender. Shares of Home Capital plunged 14.6% over the past month as of close on October 26. The stock has dropped 26% in 2018 so far.

In the past, lenders have benefited from rising interest rates, as a rate-tightening environment leads to improved margins on loans. Historically, low interest rates have seen loan books surge and now higher rates, combined with new regulations, will curb loan volumes in the near term. New OSFI mortgage rules, which came into effect in January, stipulate that even uninsured buyers are subject to a rate stress test. This has pushed tens of thousands of buyers away in 2018, according to a recent report from Mortgage Professionals Canada.

Home Capital is set to release its third-quarter results in November. In the first six months of 2018, mortgage originations are down 31% from 2017.

AutoCanada (TSX:ACQ)

AutoCanada stock has dropped 26.5% month over month as of close on October 26. Shares have plunged 55% in 2018 so far. Earlier in October, I’d recommended that investors stay away from AutoCanada for the remainder of 2018.

Auto sales have dipped in the latter half of 2018, and at this rate will fall short of the record numbers posted in 2017. AutoCanada leadership warned in its most recent quarterly report that the auto industry in Canada could be heading for a significant pullback. Auto financing has ballooned since the financial crisis, and rising interest rates will put further pressure on a company that is reeling in late 2018.

New light vehicle sales across Canada fell 7.4% year over year in September. In the second quarter, AutoCanada reported that revenue fell 1.6% year over year to $880.6 million and gross profit dropped 2.3% to $140.6 million. “The Canadian market is holding at slightly under the record sales of the last year but is also poised for a slight correction,” the company said in the Q2 report. “Rising interest rates compound this outlook but are also difficult to forecast.”

The Bank of Canada is not backing down from its rate-hike path. This will apply further pressure to an industry that is already quite fragile in late 2018.

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 Ambrose O'Callaghan has no position in any of the stocks mentioned.

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