Bank on this Play for Rising Rates

With all the hoopla surrounding the Fed’s 0.25% interest rate hike, we commented on rising rates in our Dec. 30 post titled "The Stock Market is on the Cusp of a Record-Breaking Year."

Despite contrary beliefs, rising rates are generally a good sign for the stock market.

Ned Davis Research studied the 19 times the Fed initiated interest rate increases since 1930. Here’s how stocks performed afterward …

Choppy Early, But the Market Finds its Footing Soon Thereafter

Source: Ned Davis Research

One year after the Fed’s initial interest rate hike, the market rose by 7%, on average.

Not too bad. And probably much better than most would think.

Today, we’ve extended our research to provide a specific area of the equity market poised to do well in a period of monetary tightening.

Banking.

More specifically, regional banking.

Regional banks make most of their money from traditional lending. They have a simple business model: Secure low-cost deposits and lend money to mortgage borrowers and small- to medium-sized businesses at higher rates.

Their profit comes from the "spread."

Also known as "net interest margin," it’s the difference between the lower rate a bank pays for its depositors’ money and the higher rate it charges to lend that money to borrowers.

When rates rise, it’s good for banks. That’s because banks raise loan rates faster than deposit rates.

Don’t get us wrong … big banks benefit too. But they’re much more dependent on "non-interest income" like:

  Selling various financial products (brokerage, wealth management, mutual funds and insurance)

  Private equity profits

  Investment banking income

  Currency trading, and

  Various other fees.

That’s why we’re honing in on regional banks. They will see more of a direct benefit from a rising rate cycle.

Here’s how they did the last time the Fed engaged in a policy of continued rate hikes …

Regional Bank Stocks Climbed with Rates the Last Time the Fed Tightened

Source: Nasdaq

The KBW Nasdaq Regional Bank Index gained 12.5% from June 2004 to June 2006.

There is an easy way to play this if a similar scenario unfolds …

Buy the SPDR S&P Regional Banking ETF (KRE).

With $2.6 billion in assets, KRE is the largest regional banking ETF. It yields 1.8%. And this ETF costs a modest 0.35% in expenses to own its current basket of 93 stocks.

KRE tracks the S&P Regional Banks Select Industry Index, which reflects the performance of publicly-traded regional banks or thrifts.

Not only should KRE do well in periods of rising rates, but it’s also performed well vs. bigger banks in general. Since the bottom of the financial crisis in March 2009, it’s doubled up on banks deemed "too big to fail" …

Smaller Banks Outperform Bigger Banks

Source: YCharts

With the Fed supposedly ready to embark on a prolonged period of gradual rate increases, regional banks have a good chance to outperform both big banks and the stock market.

If you’re looking for more income than KRE provides (1.8% yield), be sure to check out Nilus Mattive’s Income Superstars newsletter. He has two recommended bank plays with an average dividend yield of 3.6%. And they’re both buyable at today’s prices. If you’re a current subscriber, click here to make sure they’re already in your brokerage account. Or if you’re ready to become an Income Superstar, click here to see Nilus’ top dividend plays.

Happy trading,

The Uncommon Wisdom Daily Team

P.S. Nilus’ Income Superstars members are collecting up to 126 regular dividends per year. And in yesterday’s column, he showed you how you can create monthly income with just three stocks.