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Interest rates were cut to record lows during the pandemic from various central banks. In the US, we saw rates cut down to the zero lower bound of 0-0.25%, where they have remained since. In the UK, rates were cut twice to end up at 0.1%. However, with central bankers looking to start normalize monetary policy, interest rates look set to be hiked soon. In fact, the market is currently pricing in an interest rate hike for the UK next month. 

Why do stocks fall when rates rise?

Traditionally, stocks have an inverse correlation to interest rates. This is the case so that interest rate hikes typically see the stock market come lower. The main reason for this is that companies face higher costs when it comes to issuing or refinancing debt. The credit spread between Government bonds and corporates might remain the same, but if Government bond yield rise, this will also cause corporate debt yields to rise as well.

Higher interest costs ultimately could translate to lower profits further down the line. Although this is the case generally, there are some areas that can offer good value to invest in despite the outlook of higher interest rates.

Cut out the debt

The first area to look at is companies with low debt levels. This might sound obvious, but buying a stock that has little debt should not be impacted anywhere near as much as one with large obligations. 

It’s hard to designate industries that have this trait, but it’s worth looking at some of the large tech firms such as Apple, Amazon and Alphabet. Aside from this, individual stocks within a sector can also be worth looking at. The debt-to-equity ratio is our favored metric in this regard, that can be easily calculated.

Uncorrelated stock options

Another area to look at with interest rate hikes is heavy retail traded stocks. The main driver in the share price here is speculation, rather than fundamentals. This is a high risk way to make a play, but as a tactical allocation using a small portion of my funds, I can look to try to make gains here. Certain stocks have large intraday swings that can allow me to generate high returns in a short period of time.

Invest in dividend shares

A third avenue to look at is dividend stocks. We regularly publish and update the Top 20 dividend yield stocks from both the US and UK. At the moment, there are several UK stocks with yields 8% and above. 

Buying these stocks allows me to pick up income. Considering that my cash (even post rate hikes) is unlikely to be getting higher than a 1% yield, this is a good way to put the funds to work.

Even if the interest rate hikes push the share price down in the short run, the income can offset this. In the long run, we’d expect the market to recover.

Overall, there are several ways to deal with rising interest rates, and this doesn’t have to be negative for my stock portfolio.

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