Why You Should Avoid Interest Rate Sensitive Stocks

Hello, friends. In the process of investment and trading, both factors are equally important, what to do and what not to do. You need to be aware of both and only then, will you turn out to be a profitable investor and/or trader.

I'm Vijay Bhambwani. In this video, I want to help my viewers determine which sector to avoid in the present rising interest rate scenario.

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As I record this video on Wednesday, the 13th of July 2022, I have read the news today of South Korea's central bank increase the interest rate or coupon rate by 50 basis points, and then the Bank of New Zealand has increased the interest rate by a similar 50 basis points, and the surprise was, today Bank of Canada has increased the interest rate by a whopping 100 basis points, and all this is to curb in inflation.

The US itself has declared inflation, which was above expectation at nine plus percent, and is expected to raise interest rates in the forthcoming meetings.

Our ow RBI, the Monetary Policy Committee, the division of the RBI that is responsible for determining interest rates, is expected to meet in August 2022, and whether it will increase the interest rates further, which it already had in the past meetings, will determine the immediate outlook of the stock markets of our portfolio of investments, and how we trade going forward.

You see, while a lot of my friends are conjecturing that there is a growing school of thought that inflation or commodity price inflation rather, is more or less peaking and therefore should either plateau out or start easing lower, and that means the world need not or at least the Indian RBI's Monetary Policy Committee or MPC, need not raise interest rates as aggressively, as it was expected to do in the past.

While I concur with that view partially, there is another factor which I believe a whole lot of traders in the market are ignoring and this is something that I have a shared with my dear viewers. This is called the cash carry trade.

You see, if an outside economy is offering a higher interest rate and India is offering a lower interest rate, money tends to fly out of India into a higher interest rate bearing economy, although it's not all that simple.

Even though the economy where the money is going, the interest rate is likely lower but if the currency is stronger, money will still go towards the country where interest rate maybe marginally lower, but the currency is stronger. So it's a factor of both the currency and the coupon rates.

Now to compete and to keep the money flowing into India and even to keep the money, which is already in India stay in within India itself, we will have to match the interest rate rises, or hikes by other central banks.

Now does this have a bearing on any sector of the market which may not do as well as it was expected to do in a lower interest rate regime? In my humble opinion, yes.

Now this sector is the interest rate sensitive sector as the very name suggests. Those companies which fall in this sector, are very significantly impacted by rising interest rates.

So take, for example, any company which is very, very heavily dependent on EMI-based sales for its products, it's topline, which is the turnover growth. Rising interest rates might just see the demand for its products coming down mildly or to a varying degree. It all depends on how expensive the product it sells.

So if the interest rate is actually rising significantly and the product is a high value product, and majority of the sales are on EMI-based leverage purchases by consumers, you could see a crimping or compression in the sales volume of that company.

So interest rate sensitive stocks are likely to show a lower percentage price appreciation as compared to the other segments in the market. Or they might even log negative returns or flat returns, zero returns as compared to the other segments of the market.

Be that as it may, there is a very great possibility that this segment can be a relative underperformer of the market. So if another sector of the market is giving you 10% return and if this sector is giving you 9.5% return, that is underperformance. So interest rates sensitives normally underperform in a rising interest rate scenario because the sales of these companies tend to get negatively impacted.

The other area where interest rate hikes will impact a companies, are companies where there is a huge amount of borrowing, where there is lot of debt in the books, where the business is very heavily capital intensive, the margin of profit is low, and it's a commoditised business where high turnover is what is keeping the company afloat.

There, a rising interest rates scenario is a direct kick in the stomach and a negative impact on the net profit. Now these companies will not do as well. Here again, they will be relative underperformance.

The third segment that I feel will also fall into interest rate sensitives, are companies where the raw materials and the finished product both, are money. Now which kind of companies are these? I am talking of non-banking financial companies or NBFCs.

On one hand, they borrow money from the public by way of fixed deposits, paying interest. On the other hand, they lend this money to their borrowers, at a higher, marked up interest rate, and the difference between the interest that they pay to the depositor and the interest that they charge to the borrower, that is the profit margin.

Now here, the cost of their raw material or financing costs, the cost of money, the coupon rate, interest rate, call it what you may, will rise and raw material cost increases are not really very great for any company.

As long as this company can pass on the rise in raw material cost, which is cost of funding, and raise its interest rates without damaging the amount of loans that it disperses, I think the company will do fine. But if the demand for credit is negatively impacted or comes down slightly, that may again see the turnover coming down a bit.

In any case, in a rising interest rates scenario, when there is a certain amount of pressure on margins, the lending becomes a lot more cautious, even by the NBFCs.

So these are three kind of sectors which I would want my dear viewers to be particularly careful about. Don't leverage yourself. By leveraging means borrowing money to buy shares either in futures and options or in any other method possible. Don't go aggressive into these sectors, these stocks, these kind of industries, which I just talked about.

Let's be careful out there because rising interest rates might just keep equity markets subdued for a little while.

On this cautious note, I bid goodbye to you, not before reminding you to click like on this video if you liked what you saw. Subscribe to my YouTube channel if you haven't already done so. Click on the bell icon to receive instant alerts about fresh videos being put up out here.

Good, bad or ugly, I always look forward to your comments and feedback in the comments section and help me reach out to smart investors and traders like yourselves by referring my video to your family and friends.

I thank you for your patience in being with me in my video. Till we meet again in my next, this is Vijay Bhambwani signing off for now. I wish you have a very, very profitable day ahead.

Bye.