UK interest rates have risen from 0.25% to 3.00% this year and further hikes are likely. Higher interest rates typically cause stock market declines and some companies are particularly sensitive to rate changes. However, I’ll continue to take a long-term approach to investing. Therefore I’m searching for stocks that can thrive not only in this period of volatility but over the next 10 or more years.
Banks can earn more when interest rates rise because they charge more on the money they lend. Additionally, their net interest income (the difference between interest earned on loans and interest paid out for savings) should increase. However, an unfavorable macroeconomic environment can hit profits. With fears of the UK falling into a recession, Lloyds Banking Group (LSE: LLOY) is having a rough year. In fact its share price is down 15% in 2022.
It’s forecasting an 8% fall in house prices, a slowdown in mortgage lending and 5.5% unemployment next year. Given these grim predictions, Lloyds has put aside an extra £668m to cover losses if customers default on debts. It can absorb substantial impairment charges in the short term after net income rose 12% to £13bn last quarter. Longer term, it plans to become a major player in the UK rental market, buying 50,000 homes in the next decade. There’s an opportunity here for significant income growth. If interest rates stay relatively high and the economic outlook improves, Lloyds shares would look cheap today.
Historically, higher-risk assets perform poorly when interest rates rise. Defensive shares such as consumer staples and utilities can outperform. Vodafone (LSE: VOD) falls into that category. Its share price has been tumbling since 2014 but it could be in a strong position to weather this economic storm. The business is Europe’s largest broadband provider and is targeting significant revenue growth in Africa too. It has a global presence and its overseas revenue could be inflated by a falling pound.
Demand should remain robust for Vodafone’s services even in a recession. My concern with the company is its large debt. Standing at £42bn, this could become a major issue if earnings are squeezed while interest rates rise. Yet the company doesn’t seem too worried having launched share buyback programmes in the last year.
Tech stocks are particularly susceptible to rising interest rates. Many of them are valued based on future growth prospects that are now less optimistic. Apple shares declined 23% this year, but have fared better than the Nasdaq Composite, down 33%.
While many businesses could struggle to make ends meet, Apple has $48bn cash on hand. That could grow along with rising interest rates. It holds on to profits to reinvest in growth opportunities, company acquisitions and share buybacks. A recession would likely cause a reduction in its hardware sales and services subscriptions. But it should have no long-term issues riding out worsening economic conditions. Through smart investments, it could expand its already large and loyal customer base.
Lloyds, Vodafone and Apple dividend yields have been boosted this year as their share prices declined. This could protect my portfolio from stagnating markets. The stocks now yield 5%, 7.36% and 0.66%, respectively making all three look attractive for the coming months and years.
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Nathan Marks has no position in any of the shares mentioned. The Motley Fool UK has recommended Apple, Lloyds Banking Group, and Vodafone. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2022