How to Position a Portfolio Regardless of the Fed

09/25/2015 9:00 am EST

Focus: FINANCIALS

Matt McCall

Founder and President, Penn Financial Group

One of the sectors that historically has done well as the Fed is moving interest rates higher is the regional banks, so Matt McCall, of Penn Financial Group, highlights three ETFs in the financial sector and three regional banking stocks that could perform well in a rising interest rate environment.

The debate on when the Federal Reserve will begin to raise interest rates continues to be the hot topic over every water cooler between Wall Street and Main Street. The exactly timing of the first interest rate hike is unknown, but what is known is that the Fed will hike interest rates at some point in the near future from basically zero.

Waiting for the Fed to make the first move before positioning a portfolio is one strategy that may work. Another strategy is to begin looking at sectors and stocks that should outperform in a rising interest rate environment. One of the sectors that historically has done well as the Fed is moving interest rates higher is the regional banks.

Over the last twelve months the SPDR KBW Regional Bank ETF (KRE) has gained 4.3% versus a loss of 3.4 for the SPDR Financial ETF (XLF). For comparison the SPDR S&P 500 ETF (SPY) is down 2.4%.

KRE is composed of 93 regional bank stocks while XLF is a basket of 90 of the largest financial companies in the US. The reason KRE is considered a top candidate for rising interest rates is that the regional banks should be able to increase their lending margins. When interest rates are higher, the spread between what the bank borrows money at and the interest rate it lends to consumers or small businesses increases. Thus, the higher profit margin.

There hundreds of small publicly traded regional banks available for investors to consider when looking into the sector. A few of the standouts are below.

Cape Bancorp (CBNJ) is a $124 million company that offers its services through 14 branches mainly in Southern New Jersey. The company trades with a forward P/E ratio of 15.3 and pays a 3.5% dividend yield. Over the last year the stock is up 21% and is trading at an all-time high.

Cardinal Financial Corp. (CFNL) is a $741 million company with 32 banking offices in the Greater DC, Maryland, and Virginia area. The forward P/E ratio is 15.6, the PEG ratio is an attractive 0.85, and the dividend yield is 2.0%. In the last twelve months the stock is up 31%.

Heritage Financial Corp. (HFWA) is a $562 million company with 66 branches in Washington and Oregon. The forward P/E ratio is 14.1, the PEG ratio is 1.52, and the dividend yield comes in at 2.4%. In the last year the stock is up 13%.

All three stocks have greatly outperformed the sector and the overall US equities market over the last year and the trend should continue as the probability of higher interest rates continues to increase.

Matt McCall, Founder and President, Penn Financial Group

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