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The Federal Reserve raised interest rates multiple times in the first eight months of 2022 and if the August reading of the Consumer Price Index (CPI) is any indication, another rate hike is coming this month and it could be aggressive.
Seventy-five basis points seems likely though it’s not uncommon to hear some so-called experts calling for 100 basis points. How another increase of 0.75%, or gasp, 1%, affects stocks remains to be seen, but it chances are, it won’t be positive. Confirming as much, the S&P 500 is down almost 19% year-to-date. However, there are pockets of opportunity/less bad.
Take the case of the ProShares Equities for Rising Rates ETF (EQRR). EQRR tracks the Nasdaq U.S. Large Cap Equities for Rising Rates Index and while that strategy may seem overly nuanced, advisors that directed clients to EQRR at the start of this year are probably getting some thank-you’s. After all, EQRR is off just 5.63%.
EQRR Doing Its Job
As noted above, EQRR is soundly outperforming the broader market this year, but adding to the relevance of this ETF over the near-term is the point that this isn’t a one-off for the fund. Since coming to market in July 2017, EQRR established a track record for outperforming the S&P 500 when 10-year Treasury yields rise. In other words, EQRR doesn’t always deliver jaw-dropping returns, but it does its job.
“EQRR’s index—Nasdaq U.S. Large Cap Equities for Rising Rates Index—has more than tripled the return of the S&P 500 since the 10-Year U.S. Treasury’s lowest historical closing level in the summer of 2020,” according to ProShares research.
Past performance is never a guarantee of future returns, but it’s hard to ignore EQRR’s track record. Additionally, plenty of funds purport do to one thing and they come up short in that category. That’s not the case with EQRR and those are points to consider with more rate hikes looming.
“If interest rates continue to rise in 2022, now may be the time to explore strategies for your large-cap equities sleeve,” adds ProShares. “EQRR targets sectors that have had the highest correlation to 10-Year U.S. Treasury yields and, within those sectors, the stocks that have had a strong tendency to generate relative outperformance as rates rise.”
Sectors Matter
Experienced advisors know that, historically, some sectors perform better than others when rates rise. That conversation often centers around financial services, but with the S&P 500 Financial Services Index down almost 16% year-to-date, it’s fair to say that sector isn’t living up to historical billing.
Fortunately, EQRR is about much more than bank stocks and its primary sector allocations, which are underweight in the S&P 500, explain the ETF’s 2022 out-performance.
“Perhaps not surprisingly, financials have been at the top of the list as rising rates can lead to higher margins. In addition, energy and materials stocks both stand to benefit from the inflation that usually accompanies rising rates. As the graph that follows illustrates, EQRR’s index has a total allocation of more than 76% to the financials, energy and materials sectors, while the S&P 500’s allocation to these totals less than 18%,” concludes ProShares.