Key Points
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The Fed held off on raising interest rates last Wednesday, suggesting inflation is tame enough for now.
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The market’s still counting on a quarter-point hike before the year-end, however, and even more next year.
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The prospect of high and rising interest rates should prompt some well thought-out, strategic positioning.
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The market got something of a reprieve this past Wednesday, when the Federal Reserve chose not to raise the federal funds rate. But let’s face it: With inflation still robust, a rate hike is still in the cards sooner or later. CME‘s FedWatch tool still says there’s an 85% chance we’ll see a quarter-point increase in the fed funds rate in December, with a couple more likely in the first half of 2027.
As much as higher interest rates can slow economic growth, this doesn’t mean you should get out of the market altogether. It just means you might want to rethink your allocation. To this end, here’s a closer look at some simple ETFs to consider buying as a way of playing defense.
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Three rising-rate ETFs to consider
In most cases, when interest rates are high and/or rising, equity real estate investment trusts (REITs) perform well, while energy stocks fare even better. Indeed, number-crunching by mutual fund company Hartford finds that in years when inflation is over 3%, the energy sector outperforms inflation 74% of the time, with an average 13% gain. This suggests you should consider stakes in funds like the Vanguard Real Estate ETF (NYSEMKT: VNQ) and the State Street Energy Select Sector SPDR ETF (NYSEMKT: XLE).
But in both cases, I’m not convinced this will be the case this time around. Renters (corporate and consumer) are struggling, and with crude oil prices holding at $100 per barrel since March, these names are already fully valued.
So what might actually do well from here if lingering inflation forces the Fed to keep raising interest rates?
I’d start with something like the State Street Materials Select Sector SPDR ETF (NYSEMKT: XLB). While the SPDR Gold Shares (NYSEMKT: GLD) is my usual go-to inflation hedge, it’s strangely underperformed since early this year despite continued inflation. The disconnect implies GLD may be losing its effectiveness as that hedge specifically because so many people are now viewing it as one. Loaded with chemical companies and industrial materials names, XLB doesn’t face that same problem.
Another fund to think about for the foreseeable future is the ProShares Equities for Rising Rates ETF (NASDAQ: EQRR). Just as the name suggests, this ETF is purpose-built for the very environment we may be on the verge of entering. It specifically holds stocks that have historically performed well when rates are rising. Its constituents currently include somewhat obscure names like Ovintiv and Zscaler, but this disconnect from the broad market is how and why the fund works as intended.
The final fund I’m expecting to benefit from rising interest rates is the Invesco S&P 500 Quality ETF (NYSEMKT: SPHQ). You always want to own quality names. That’s not quite why you might want to look at SPHQ here and now, however. Meant to mirror the S&P 500 Quality index, this fund specifically only holds names like Mastercard and Costco Wholesale that aren’t highly debt-leveraged, and therefore are only minimally impacted if and when interest rates are edging higher.
Just don’t feel like you need to sell your true “forever” holdings just to make room for these exchange-traded funds. While rising interest rates may undermine stock prices, for quality stocks, it’s only a temporary headwind.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CME Group, Costco Wholesale, Mastercard, Vanguard Real Estate ETF, and Zscaler. The Motley Fool has a disclosure policy.
