This Is the Best Sector for Stocks Amid Rising Rate Concerns, Says Bank of America

Financial stocks get high marks from Bank of America Corp.’s quantitative strategists as an area to invest amid growing concern about rising interest rates.

In addition to ranking No. 1 in the bank’s quant model, the financial sector has the highest possible score on all three of its components: earnings-per-share revisions, price momentum, and valuation, Bank of America’s quant and equity strategists said in a report Friday.

“The sector is the biggest beneficiary of rising rates,” they said. “Resumed buybacks also provide support, and the sector screens as high quality at low valuations.”

Stocks have recently taken a hit after reaching record highs this month, with the Standard & Poor’s 500 index falling about 2 percent this week through February 25. Bank of America’s strategists are also bullish on industrials due to the increased probability of fiscal stimulus and an infrastructure bill, while recommending that investors “steer clear” of long- and short-duration equities.

That means underweighting “hyper-growth” stocks as well as short duration, or “bond-proxy,” sectors harmed by rising rates, according to the report. While mutual funds have piled into communication services — where managers find exposure to growth through internet stocks as well as bond-proxies such as telecom — Bank of America is underweighting the sector.

“Tech, health care, communication services are the biggest losers under the Biden tax plan,” the bank’s strategists said. “As the economy recovers, discussions about a reversal of 2018 tax cuts could begin as a means of addressing the ballooning deficit.”

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The report shows “record crowding” in communication services by long-only funds and that technology giants in the sector face a tough 2021 for net income growth compared to last year. Real estate, another area crowded by mutual funds, will see structural “work from home” pressures as the Covid-19 pandemic reshapes demand for properties, according to the report.

Bank of America is underweight real estate as well as consumer staples. Staples, which benefited from surge in demand in the Covid-19 crisis, will probably lag in the re-opening of the economy as the pandemic ends, according to the report.

By contrast, energy has been the best performing sector this year and still has some upside, according to Bank of America. “We remain overweight energy as oil prices remain firmly above” $60 a barrel, the equity and quant strategists said.