Industry ETFs To Consider When Rate Hike Chatter Resumes

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By the time Thursday rolled around, it probably was not that surprising that the Federal Reserve opted not to raise interest rates. Fed funds futures indicated that fewer than a third of traders were betting on such an outcome.

It's Not Over 'Til It's Over

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Just as Cubs fans say there is always next year (and to the team's credit, next year might be this year), Fed watchers say there is always next month.

So as the calendar inches closer to the central bank's October meeting, all the rate hike conjecture and speculation is likely to intensify again.

Translation: Investors would do well to not take their eyes off the industry and sector exchange traded funds that could rally when the Fed finally increases borrowing costs.

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Keep Your Eyes On The Ball

Reexamining asset allocation for a potential rising rate period should extend beyond fixed income. Investors may also wish to consider tilting core US equity exposures to sectors and industries that benefit from operations positioned to profit from higher rates and improving economic growth. Consumer Discretionary and Financials are two interest-sensitive and cyclical sectors that we feel may benefit most in a potential rising rate period, said State Street Global Advisors Head of Research Dave Mazza in a note out Thursday.

Within the financial services space, ETFs such as the SPDR KBW Regional Banking (ETF) (NYSE:KRE) are expected to benefit when rates finally do rise.

It is that sensitivity to interest rates that explains KRE's drop following the Fed meeting Thursday and why the largest regional bank ETF is trading lower by 2.4 percent at this writing.

What To Expect

Rising rates should lead to improved profitability as banks net interest margin on loans improve. The financial sector and related sub-industries, banks and regional banks, display the strongest positive relationship to rising interest rates with regional banks exuding the highest of any sector or industry, said Mazza.

This is how sensitive KRE is to rising rates. From February 2 through June 10, 10-year yields climbed 80 basis points, contributing to a gain of almost 19 percent for the regional bank ETF over that span.

Another industry ETF to consider when rates finally rise is the SPDR S&P Homebuilders (ETF) (NYSE:XHB). The reason for this is because so much of the Fed's decision on rates is tied to economic data such as employment numbers, discretionary spending and housing numbers the very data points that affect an ETF like the equal-weight XHB.

The strong employment backdrop has buoyed homebuilder sentiment, housing demand and household spending. Incorporating discretionary housing industries, such as home improvement and furnishing retail, and expanding beyond concentrated positions in new home construction firms is the preferred approach to capturing the full effects of this bourgeoning housing market, added Mazza.

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