Higher For Longer: These Sectors And Stocks Could Thrive Under Higher Interest Rates

This year, the financial landscape has been shaped by high interest rates and tenacious inflation, a combination of scenarios that have significantly influenced various sectors of the economy. 

For investors, high-interest rates often provide a two-way scenario, whereby many of them leverage new opportunities that may arise from current conditions, or perhaps leave them reshuffling their strategic approach in hopes of weathering potential losses and slower growth potential. 

The higher interest rate environment has further created more unanswered questions about the forward-looking prospects of the economy and equity markets. Yet, despite these and other conditions influencing the performance of certain sectors, analysts, investors, and economists remain positive that the U.S. economy could be approaching a soft landing, perhaps curbing the possibility of a minor recession, altogether. 

Interest rates: Where are we now? 

Following a series of interest rate hikes kickstarted by a monetary tightening policy initiated by the U.S. Federal Reserve back in 2022 in an attempt to lower its federal fund sheets and slow down an overheating economy, interest rates remain historically high. 

To combat sticky inflation and rising costs, the central bank has raised rates 11 times between March 2022 and July 2023. Since halfway through last year, the Federal Open Market Committee (FOMC) has taken a more conservative approach to further raise interest rates over the potential fear of sending the economy further over the cliff. 

For many, the decision to pause rate hikes meant that the FOMC could see a light at the end of the tunnel, and a soft landing was perhaps imminent. However, over ten months since the last rate hike, the central bank’s federal fund rate is still sitting at a nearly two-decade high. 

Since May 2024, interest rates remain unchanged at 5.25% to 5.5%. Following a committee meeting on May 1, 2024, the FOMC decided to maintain a more aggressive stance of leaving interest rates higher for longer. 

The FOMC argues that they continue to gauge economic activity, including labor market conditions, wage growth, and consumer spending before they’re willing to pull the trigger and lower interest rates. 

The decision to leave rates unchanged was expected, with some signaling that the Fed will only begin cutting rates once they begin seeing weakening prices, slower consumer spending, and more moderate labor market data, according to Reuters. 

Notably, committee members continue to hold a somewhat neutral stance regarding further rate hikes. Current projections estimate that the central bank will signal three cuts this year, with the potential of an additional three cuts in 2025. 

Currently, the central bank continues to sit tight on its decision to raise rates further, with the intention of smoothing out its balance sheets without causing further economic turbulence. 

Chair Jerome Powell pointed out that economic growth stands at 3% while inflation is below 3%, by some measures, and that further changes to their long-term outlook could leave financial markets in turmoil. 

Coming from their most recent meeting, it’s clear that the central bank is willing to hold rates higher for longer, something analysts expected, although uncertainty over when a potential rate cut may be on the books is still not clear. 

For investors, and most billionaires in the world, these conditions pose new challenges, but could present new opportunities. By leveraging potential within capital markets that could benefit from higher interest rates, and further maximizing exposure to sectors that are sensitive to wider economic conditions can ensure that investors navigate the current environment more effectively. 

Sectors benefiting from high-interest rates 

For most companies and individuals, higher interest rates typically increase the cost of borrowing, slowing the potential of economic expansion, and improving operations and eating into corporate profits. 

Companies with high levels of rolling debt often experience the most impact, as debt levels continue to climb and profitability declines over time. With limited ability to access capital to increase operations or initiate expansion projects, many of these companies tend to find themselves in a situation where they feel not only their revenue being impacted, but witness a reduced investor interest as stock performance steadily wanes. 

Alternatively, higher interest rates don't only affect companies. Consumers begin to notice a sharp increase in personal loans, mortgages, and credit cards. These conditions steadily reduce consumer spending, as more individuals begin stocking away their cash, and lower discretionary spending. For companies in consumer-driven sectors, the reality becomes more clear as revenue begins to decline, and profitability is impacted. 

These scenarios have become a new reality, something which many investors have started factoring into their strategic planning. However, not all companies are affected similarly, and some companies see improved bottom-line performance during a period of higher interest rates. 

Financials 

There’s perhaps an unwritten rule that says “Financial First” during periods of high-interest rates. Many companies in the financial sector including banks, mortgage lenders, insurance providers, and fintechs often experience periods of better-than-expected growth when interest rates are climbing.

High interest rates create a catalyst of complex, and potentially profitable scenarios for banks and financial institutions. Primarily, many of these companies tend to earn higher margins from the interest they charge on loans and the interest they pay on deposits. 

Banks and other financial institutions may see widening profit margins during these periods, as they begin to generate more income from loans compared to the interest paid. For others, such as insurance providers, investment and wealth managers, and portfolio managers, those who tend to hold interest-sensitive assets could see their portfolios swell under rising rates. 

Healthcare 

Another sector that tends to witness steady demand throughout economic uncertainty is health care. Much of the sector is somewhat resistant to inflation and higher interest rates, making healthcare companies more defensive against economic volatility. 

Regardless of conditions, healthcare services, medical devices, equipment, and professional services will experience steady demand throughout periods of volatility, as individual consumers, aging populations, and advances in healthcare technology contribute to the sectors’ ability to wane off financial and economic risks. 

Additionally, healthcare companies that design, develop, and manufacture new devices might see steady growth over these periods, as consumers will continue to seek treatment, regardless of interest rates, inflation, or the cost of healthcare. 

Healthcare companies tend to have better financial diversification, allowing them to generate revenue through multiple streams of revenue. The large number of annual mergers and acquisitions helps to play in favor of revenue diversification for major healthcare companies. 

However, it’s important to consider that high interest rates could pose near-term operational threats for healthcare companies due to the increased cost of borrowing, and seemingly restricted access to capital to increase production or provide more comprehensive products and services within a competitive environment. 

Energy 

Aside from high interest rates, the energy sector is often influenced by various environmental, governmental, and political factors. Additionally, the sector typically sees a nearby correlation with economic activity, which could translate into increased revenue and profitability. 

For instance, rising interest rates could boost the significance of a stronger economy, leading to an overall increase in demand for energy sources, including coal, natural gas, and some renewables. 

More than this, the energy sector is often influenced by geopolitical events taking place across the world, and most importantly within countries that have an economy largely based on fossil fuels exportation. 

Nonetheless, energy stocks are reliant on the supply and demand of consumers, something that remains gradual throughout monetary policy cycles. Although investors don’t typically gravitate towards these stocks during periods of low demand and increased supply. 

To make sense of this, the energy sector’s performance is largely linked and partially dependent on economic growth. As the economy begins to see stabilization following interest rate hikes, consumer and corporate energy demand will remain steady, regardless of the central banks’ decision on interest rates. 

Stocks worth picking during a higher for longer environment 

Morgan Stanley

Sector: Finance 

Investment banking conglomerate Morgan Stanley (NYSE: MS) has managed to largely capitalize on the high-interest rate environment, reaching $7 trillion in client assets across its wealth and investment management business segments, following its Q1 2024 results. 

The company believes that investors should begin looking beyond passive income exposure, taking a more selective approach to stocks, and instead invest their capital in companies with high-quality cash flow, better competitive advantages, and realistic earnings goals. 

As a result of strong new asset growth, the company reported a 7% improvement in revenues compared to a year ago. In total, the company reported $15.1 billion in first-quarter revenue compared to $14.5 billion for the same period last year. During the financial release, the company declared a diluted share price of $2.02 in $3.4 billion net income. This is an improvement from $1.70 per diluted share with a net income of $3.0 billion compared to the same period last year. 

Additionally, interest income remains strong, with Morgan Stanley reporting a 1% improvement from Q4 2023 and a 30% increase compared to Q1 2023. Stock prices have surged 24.61% during the last six months, however since the turn of the year MS is down nearly 3%. 

The Charles Schwab Corporation

Sector: Finance 

With over $9.1 trillion in assets under management (AUM), Charles Schwab (NYSE: SCHW) managed to pull out all the stops seeing steady improvement across the board as wider macroeconomic conditions began to improve. 

Based on Q1 2024 financial earnings, Charles Schwab reported net revenues of $4.7 billion, a 6% improvement quarter over quarter. Total net income of $1.4 billion translated into $0.68 diluted earnings per share. Compare

On top of that net interest revenues were somewhat stronger than anticipated with total interest income improving by 5% compared to Q4 2023 and 19% compared to Q1 2023. Additionally, the company witnessed a net inflow of $14 billion for its managed investing solutions, largely headlined by fee-based solutions which have increased by 60% compared to the same period last year. 

The last six months on the stock market have seen stock performance increase by 35.75%, while year-to-date performance is standing at 7.92%. Overall, Charles Schwab holds a steady position considering the somewhat marginal improvements on its balance sheet and the higher interest rates the company is paying. 

J.P. Morgan Chase

Sector: Finance 

A lot is happening at J.P. Morgan Chase (NYSE: JPM), and investors are keeping a close eye as the bank continues to hold a somewhat optimistic outlook regarding the longer higher scenario that the Federal Reserve is flirting with. 

For starters, the bank reported a strong first quarter, delivering a net income of $13.4 billion On average, the company now holds an exceptionally high capital ratio of 15% with attractive peer-lending returns providing the J.P. Morgan with increased capacity and financial flexibility. 

Other important financial moments from Q1 2024 include a 17% improvement in loans and a 1% improvement excluding First Republic. Overall, new deposits remained flat, declining 3% excluding the First Republic. In total, the company now holds more than $3.6 trillion in assets under management, representing a strong increase of 19% for the first quarter.

Net interest income witnessed steady improvements, climbing 11%, or roughly 5% excluding First Republic. In total, net income was up 39% to $1.9 billion, while total revenue of $4.0 billion marked a strong Q1 for the company’s commercial banking segment. Commercial banking revenue was offset by higher deposit-related client credits and stronger growth for payments. 

April was a rocky time on the stock market for JPM with stocks sliding nearly 7% in single-day trading before plateauing for several days. Since the decline, stocks have managed to regain traction, climbing 6.55% since the low, and seeing an 11.49% year-to-date improvement. 

Eli Lilly 

Sector: Healthcare & Pharmaceuticals

There’s plenty to be excited about with Eli Lilly (NYSE: LLY) as the healthcare and pharmaceutical giant has already raised its 2024 guidance by more than $2 billion following its stronger-than-expected first quarter results. 

Overall, Q1 2024 has been promising, with quarterly revenue growing 26% largely driven by strong demand for Mounjaro, Zepbound, Verxenio, and Jardiance. Despite interest rates sitting at a near-two-decade high, Eli Lilly managed to improve bottom line performance through a mix of higher realized prices, with a 33% gross margin increase, new favorable products, and the steady improvement of production costs. 

For Q1 2024 the company reported earnings per share (EPS) of $2.48 per share, representing an increase of 66%. Total full-year revenue has been raised by $2 billion, now sitting at a range of $13.50 to $14.00 billion, with an EPS guidance of $1.30 per share. 

Investors have caught wind of Eli Lilly as the company announced the introduction of a new weight loss drug as a way to compete against leading contenders such as Ozempic and Wegovy. On a year-to-date basis, stock performance has improved by 31%, while the company has seen a significant bump in its stock price following the announcement of new product testing, with LLY jumping nearly 10% since the announcement was made in February. 

Catalent

Sector: Healthcare & Biotechnology 

Earlier this year, Novo Holdings, the holding and investment company for Danish biotechnology and pharmaceutical conglomerate Novo Nordisk Foundation announced entering into a merger agreement with Catalent (NYSE: CTLT) through which it will acquire the company in an all-cash transaction of $16.5 billion. 

The news was a surprise to some, although Catalent, a leader in health-tech innovation, has found that Novo Holdings can provide the company with a more significant foundation through which it can develop more innovative biotechnology products. 

Catalent isn’t allowing itself to be pushed around on the playground despite the company missing its target estimates, with revenue being in line with expectations. Overall, revenues fell by 10% in Q2 2023 compared to Q2 2023. Based on Q2 2024 net revenue, excluding COVID-related revenues of $260 million in Q2 2023 and $75 million in Q2 2024, total performance increased by 8% compared to the same period last year. 

Shareholders received some good news after all, the company raised more than $600 million in term loans and used the proceeds to pay off its revolver of $1.3 billion in total available liquidity. 

The announcement of Novo Holdings acquiring Catalent left stocks sliding nearly 6% on February 5, after the company broke the news. However, conditions remain steady, with CTLT seeing strong performance this year, as stock prices are up by 25% since the turn of the year. 

Intuitive Surgical Inc

Sector: Healthcare and Healthcare Technology 

Intuitive Surgical (NASDAQ: ISRG) is considered one of the leading developers and manufacturers of clinical and surgical equipment, providing minimally invasive surgery solutions. 

Highlights from its Q1 2024 financial results revealed that the company is in better shape than ever before, with its da Vinci Surgical System, its flagship development, seeing an improvement of 16% compared to Q1 2023. 

In total, the company expanded the availability of its da Vinci systems with a total installed base of 8,887 systems as of March 31, 2024, representing an increase from 7,779 at the end of the same quarter last year. In total, revenues increased 11% from $1.70 billion in Q1 2023 to $1.89 billion in Q1 2024.

During their earnings announcement, executive management mentioned that despite the positive quarterly turnaround, wider economic challenges such as inflation and high interest rates, along with geopolitical tension in key market areas such as the Middle East and Ukraine continue to hamper their development prospects and supply chains. 

Marathon Petroleum 

Sector: Energy & Petroleum 

Fossil fuel refining company Marathon Petroleum (NYSE: MPC) has quickly become a bode for hedge fund managers following its better-than-expected Q1 2024 earnings results. 

On April 30, 2024, the company announced their first quarterly earnings, with an adjusted net income of $937 million, or $2.58 per diluted share. In total, the first quarter was strong in terms of net cash from operating activities which contributed more than $1.5 billion to their balance sheet.

Despite the harsh interest rate environment, Marathon Petroleum successfully completed planned maintenance at four of their largest refineries, marking not only the biggest of such projects for the quarter but also in the company’s overall history. 

Additionally, the company announced the acquisition of Utica midstream assets, with $550 million distributed to Marathon Petroleum, allowing them to accelerate the development of their processing plants in the Marcellus and Permian basins. 

With strong capital flow, the company managed to allocate an additional $5 billion in share repurchase authorization, which has totaled $35 billion of total capital returned since May 2021. 

In early April, MPC reached a peak of $219.13 per share on the stock market before beginning to slide. Since the beginning of the year, MPC has improved by nearly 19%, holding a steady pace on the market despite reporting a harsh operating environment due to supply chain constraints in the Middle East. 

Valero Energy Corp 

Sector: Energy & Petroleum 

The American downstream petroleum company Valero (NYSE: VLO) has seen the impact of higher interest rates take a toll on its balance sheets, however, the company remains positive that following a less-than-overwhelming first quarter, they’re willing to embrace the long-term benefits that comes with prioritizing investor capital return over near-term profitability. 

For instance, the company repaid more than $167 million in outstanding principal balance of its Senior Notes which matured in March. Additionally, Valero returned more than $1.4 billion to stockholders through dividends and stock buybacks, which the company is hoping would pay off in favor of gaining long-term investor loyalty. 

Based on Q1 2024 financial earnings, the company reported a net income of $1.2 billion, or $3.75 per share, while the adjusted net income of stockholders was $1.3 billion, or $3.83 per share. 

Compared to the same quarter last year, Valero has seen net income decline from $3.1 billion, or $8.29 per share. Nonetheless, the company declared a regular quarterly dividend of $1.07 per share following its Q1 2024 earnings. 

Not all is completely lost. Stocks are showing some signs of slowing down following a strong mid-quarter performance. Overall, stocks are down 14.85% from its earlier peak in April but have improved nearly 20% since the beginning of the year. 

Overall, Valero is holding out despite the challenging conditions. The company remains focused on its near-term project goals, including the SAF project at the DGD Port Arthur plant with a total sticker price of $350 million, which is expected to be completed in the fourth quarter of the year. 

Finishing Thoughts 

High-interest rates are expected to be around for longer than expected, although should the central bank reach its inflation targets in the coming months, there might be some light at the end of the tunnel, which could suggest a potential soft landing for the economy. 

Until then, investors and fund managers are keeping a close eye on conditions, focusing their attention on companies that are well-positioned in sectors that are less interest-sensitive and can provide them with the stability needed to ride out the uncertainty.