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7 Stocks to Buy for a Possible Fed Rate Hike

Did strong job growth accelerate Janet Yellen's rate hike timeline?

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Just when it looks like the Federal Reserve has time and room to hold off on its next rate hike until next year, a rock-solid jobs report on Friday, August 5 comes along and forces the market to reconsider the Fed’s likely timeframe. Rather than the expected creation of 185,000 new payrolls in July, the nation mustered 255,000.

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Better still, June’s count was revised upward to 292,000. They aren’t jaw droppingly large, but in that job growth is one of the Federal Reserve’s most-watched yardsticks in the rate hike debate, there’s no denying such interest rates could rise much sooner than expected before Friday of last week.

That’s not necessarily a bad thing for all stocks. Indeed, there are some stocks that would actually thrive in a rising rate environment.

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With that as a backdrop, here’s a closer look at seven of the best stocks to buy now that a Fed rate hike — and maybe even a string of rate increases — could come sooner than later.

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Bank of America Corp (BAC)

While most sectors and industries have been loving the low-rate (read “cheap borrowing”) environment we’ve been in for years now, there is one sliver of the market that’s hated it … banks.

Banks predominantly make money by lending money, charging interest rates higher than their own borrowing costs and pocketing the difference. Problem: The lower the economy’s base interest rate is, the less banks pocket. Higher interest rates would mean a relatively wider difference between the two rates.

In other words, banks earn more the higher interest rates are.

This is true of all banks, though not all banks are run the same. One of the better-managed bank stocks to buy should the Fed pull the trigger on a rate hike in the near future is Bank of America Corp (BAC).

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Why is BAC stock a better bet than other banks should interest rates begin to tick higher? Giving credit where it’s due, it was Deutsche Bank that calculated Bank of America’s highly levered bottom line was more sensitive to interest rates than any of its peers, and could grow 20% on just a 1% point increase in long-term rates.

Chubb Ltd (CB)

For the same basic reason, banks do better when interest rates are higher, so do insurers like Chubb Ltd (CB).

To be clear, higher interest rates don’t work in the favor of insurance companies in all ways — there are downsides. One of them is the fact that the bonds held by insurers — for the sake of safety and reliability — lose value when rates are rising just like they do for retail investors. That can crimp the value of an insurance company’s investment pool, which may be needed to pay customers’ claims.

All the same, higher interest rates do insurers more good than harm, and Chubb is no exception. Indeed, Chubb is a standout in terms of corporate management.

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In the insurance industry, the so-called “combined ratio” compares expenses and payouts to premiums, or revenue, collected. A combined ratio of less than 100% means the insurer is effectively managing its investment policies while also effectively selling policies. Chubb’s combined ratio has been below 100% every year since 2002.

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In other words, it’s a well-run company, in good times and bad, in all sorts of interest rate environments.

TD Ameritrade Holding Corp. (AMTD)

Yet another financial segment that benefits from higher interest rates and the subsequently wider profit margins they bring with them are online discount brokers, though in a slightly different way than banks.

When rates move higher, money market rates move upward as well. And, incredibly enough, some of the e-brokers make more money on clients’ cash balances than they do from the trading commissions those customers drive.

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Arguably the best online-trading firm is TD Ameritrade Holding Corp. (AMTD). It’s into its fourth straight year of rising revenue and rising earnings in a period where growth was tough for others to muster.

The company also set up more such growth last quarter as well, proving it knows how to continue drawing a crowd when interest in trading is waning. Total client assets grew 5% on a year-over-year basis, trading was up nearly 7%, and perhaps most importantly, interest rate sensitive assets like money markets were up 10% on a year-over-year basis last quarter.

A little interest rate nudge could go a long way for AMTD stock.

Brocade Communications Systems, Inc. (BRCD)

Brocade Communications Systems, Inc. (BRCD) is arguably one of the last names one would expect to see on a list of stocks to buy before or during a cycle of interest rate hikes from the Federal Reserve. But, there’s a method to the madness.

There are actually two things going on here (well, maybe even three) that bode well for BRCD stock should rates move higher for the short run or the long haul. One of them is the simple fact that Brocade Communications isn’t heavily reliant on debt, and therefore doesn’t pose, or face, any major refinancing risk.

To be clear, the $4 billion technology company does have long-term debt: $802 million of it to be exact. It’s also got $1.42 billion in cash (and securities) in the bank right now, and could pay that debt off in one fell swoop if it chose to do so.

More than that though, Brocade Communications Systems has a consistent cash flow via sales of its networking equipment. And, technology stocks tend to enjoy even greater demand when rates are rising, as higher interest rates tend to coincide with an improving economy.

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Better still, BRCD stock is in a unique position within the technology sector in the face of higher interest rates because it’s dividend is well protected. Over the past four quarters it’s only dished out 21% of its net income as dividends, leaving the company plenty of room to pay out more if warranted.

ProShares Short 20+ Year Treasury ETF (TBF)

It’s not exactly a big secret that when interest rates go up, bond values go down. So, bet against falling bond prices in a rising rate environment. How? With a bearish bond ETF — an exchange-traded fund that gains in value when the bonds lose ground.

There are several options, some of which are leveraged (meaning they’ll gain 2% or even 3% for every 1% decline in a particular bond’s value). But even a basic 1:1 fund like the ProShares Short 20+ Year Treasury ETF (TBF) will do well as rates creep higher.

Since early 2010, the TBF ETF has fallen nearly 60%, in step with a decline in interest rates to generational lows. It’s arguable that interest rates are structurally incapable of going much lower, meaning the ProShares Short 20+ Year Treasury ETF has very little downside left to dish out, yet has plenty of upside.

While the near-term upside in TBF is compelling, should the economy perk up and force the Federal Reserve to log a string of rate hikes, the ProShares Short 20+ Year Treasury ETF could make for a nice long-term holding.

Alphabet Inc (GOOGL)

Not unlike BRCD stock, Alphabet Inc (GOOGL) is one of those names that doesn’t rely heavily on debt, and could pay off its mere $2 billion in long-term obligations by writing a check today — it’s got a cash stash of $13.6 billion and another $64.8 billion in short-term investments.

That’s not the biggest reason you’d want to own Alphabet in the shadow of a rate hike (or rate hikes), however.

No, the reason Alphabet makes for a solid play in the face of more hawkish action from the Federal Reserve is simply that Alphabet (mostly thanks to Google) is one of those companies that just continues to grow its top and bottom line regardless of what the economy or the market is doing, and no matter how rough things get.

The evidence: In 2008, in the heart of the subprime crisis, Alphabet managed to grow the top line to the tune of 31% and expanded the bottom line a bit as well. In 2009, with the echoes of the crises still ringing, then-called-Google grew the bottom line by more than 50% on a respectable improvement in revenue.

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Point being, there’s not much that stands in Alphabet’s way.

iShares S&P 500 Value Index ETF (IVE)

Last but not least, some experts say growth stocks are better performers than value when the Fed starts to ratchet rates upward. While others who’ve researched the matter say value dishes out better gains than growth stocks do in the shadow of rate hikes.

Both schools of thought make arguments that hold water, but the value argument tends to tout more (and stronger) evidence. As Patrick O’Shaughnessy explained, value has outperformed growth in 14 of the past 17 periods of rising interest rates.

So, assuming a rate hike in the near future is an indication of economic strength that will induce the Federal Reserve to raise rates even more in the foreseeable future, one of the best stocks to buy here may not be a stock at all.

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Instead, step into the iShares S&P 500 Value Index ETF (IVE) and just ride the big wave with a simple, stress-free position.

This article is from James Brumley of InvestorPlace.

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