The Market is Scared of Rising Rates, but You Shouldn't Be

Stocks like JPMorgan Chase and American Express are on the ropes today due to comments from St. Louis Fed chief James Bullard. The market's fear may be your opportunity.

Jun 26, 2014 at 1:00PM
Take The Long View

The Dow Jones Industrial Average (DJINDICES:^DJI) opened trading Thursday with a triple-digit slide before recovering to a less severe 81-point decline by 1 p.m. EDT. The movement came on the heels of lower than expected consumer spending in May and talk of higher interest rates from St. Louis Federal Reserve Bank President James Bullard.

Twenty-nine of the 30 Dow components were down at the time of this writing, with particularly bearish movements from the index's financial components. American Express (NYSE:AXP)was down 1% by early afternoon and megabank JPMorgan Chase (NYSE:JPM) had shed 0.7%.

Jpmorgan Window

Two reasons markets are scared of rates rising

No other industry is as directly connected to a changing interest rate landscape as banks. These companies use macroeconomic rates to set prices for both loans and deposits. The difference between the interest rate a bank charges for its loan products and what it pays for its deposit products is its primary driver of profitability.

When interest rates change, the transitional period is marked by a few factors that can be problematic for banks and bank investors. However, in the long run higher rates generally mean that the spread between loans and deposits will grow (and bank profits will then follow suit). 

First and foremost is demand for loans. When rates rise, loans become more expensive, making the value proposition of accepting that loan offer more difficult for individuals, small businesses, and large corporations. Last summer, for example, a sharp rise in mortgage rates effectively ended the mortgage refinance boom most banks were relying on to drive revenue during the post-recession "new normal."

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts.

That slack in the refinance market continues even into 2014. As of the end of the first quarter, JPMorgan had seen a 32% sequential drop in its retail mortgage business and a 24% drop in its wholesale mortgage business. 

Second, loans and deposit rates don't necessarily change at the same pace. For example, many loans have fixed interest rates that will never change. Loans could also be adjustable rate, but only reset at certain times. This reset period could range from two to five to even seven years. Deposit products generally reset much faster than this, causing a potential short-term squeeze on the bank's margins.

But that's shortsighted thinking; stay focused on the long term
That said, there are significant and pertinent long-term positives from rising rates.

The Fed's move to boost rates would indicate that the broader economy is sufficiently recovered to handle the short-term shock. That was Bullard's point today. 

Bullard said inflation is turning around and making its way toward the Fed's 2% objective. Excessive inflation is generally bad, but moderate inflation indicates healthy and self-sustaining growth. And that strong growth is exactly what this economy has been missing for going on six years now. 

The labor market is vastly improved and seems to be gaining more momentum each month. Gross domestic product disappointed in the first quarter, giving Bullard and others "heartburn," but most economists agree that the 2.9% decline in U.S. productivity was an anomaly. The consensus is for second-quarter growth to meet or exceed 3%. 

US Unemployment Rate Chart

US Unemployment Rate data by YCharts.

Speaking to the bank industry specifically, higher rates will generate more profit. In the bank's last annual report, JPMorgan CEO Jamie Dimon estimated that a return to higher, more historically normal rates would boost the bank's profits by $6 billion annually. That's a 25% increase over the bank's 2013 adjusted earnings, after tax.

American

For most of the larger banks -- the JPMorgans and even American Expresses of the world-- the transition to higher rates will not be as horrible as the market seems to expect. These companies have sophisticated interest-rate risk models that mitigate possible scenarios. The result of this hedging is smooth earnings even as rates move higher. 

The takeaway
If rates do rise sooner rather than later, that is a long-term positive. It is an indication of a strong economy and, specifically for banks, a sign of profit growth ahead. The market reaction today is overly concerned with the end of cheap money and the possible short-term impacts of a sooner than expected change in interest rate policy. 

Keep your eyes focused on the long term, as this volatility will almost certainly present some very lucrative opportunities.

Bank of America + Apple? This device makes it possible.
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its destined to change everything from banking to health care. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here

Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends American Express. The Motley Fool owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers