This is why equity investors should not be afraid of rising interest rates.

Rising interest rates can trigger alarms in the stock market, but strategists say be prepared, don’t be afraid.

For now, interest rates are rising with the idea that inflation will rise as well.

But the alert right now sounds more like a smoke alarm and a burning pan than a burning house.

“This is less about the absolute level of returns and more about the speed it takes to get there, and right now we’re not worried about speed,” said Julian Emanuel, chief strategist of equities and derivatives. the BTIG.

The most careful return is the 10-year reference Treasury, which influences mortgages and other loans.

It was lower on Tuesday, at 1.16%, after reaching the key level of 1.2% on Monday. At this level, strategists say it would move towards 1.25%, which could launch another break above. At the end of January, the yield, which moves at the opposite price, reached a minimum level of 1%.

Bond professionals say yields are higher and rising for several reasons.

An important factor is the Covid fiscal stimulus, the $ 900 billion approved in December and the $ 1.9 trillion plan that is now making its way through Congress.

Better growth is expected because of federal money, but this results in more debt and possibly inflation. This is another reason for higher yields.

Emanuel from BTIG said he would be worried if the 10-year yield would start to rise higher. It is expected to reach 1.7% by the end of the year.

However, if it moves too fast, stocks could reach a difficult spot. For example, a hazardous area would be about 1.34% if the 10-year yield reached that level as early as this month.

“This would probably be a title that would limit market growth and cause additional rotation, away from high multiple growth stocks and in cycles and value,” Emanuel said.

“Cyclical, in particular, could absorb this type of rotation and could keep the market moving sideways,” he added. “The same speculative interest that the public has shown in technology stocks … it is quite possible that, at some point in 2021, you will get a degree of speculative fervor that you have seen in those types, in the financial direction.” .

The S&P financial sector has grown by about 6% since the beginning of the year.

Banks moved higher as the yield curve worsened. This simply means that the gap between short-term rates, such as two-year rates, and long-term rates, such as 10-year rates, has widened.

That so-called steeper curve helps banks make money, as they can borrow at very low rates in the short term and can borrow at a higher rate for longer periods of time.

Bank of America strategists say energy and technology hardware are among the expensive sectors that could be affected by rising rates. They added that banks, the diversified financial sector and semiconductors are among the cheapest sectors that benefit from rising rates.

But strategists say Treasury yields, while rising, are far from competing with dollar-denominated stocks.

Lori Calvasina, head of US action strategy at RBC, said there was no set 10-year level to trigger negative action, but “3% feel that the place where people in the past tended to care.”

Calvasina said it monitors the number of S&P 500 companies that pay dividends over 10 years. At the beginning of the year, 63% of S&P 500 companies had dividends in excess of 10 years, and a few weeks later it was 56%.

“If it drops to 20% or 30%, at this level the market could start fighting,” she said. If the market does not face problems at that time, there are still problems and investors see a lower return.

The rising rate and inflation trade largely represent the rotation of cyclical values ​​that began in the second half of last year, as vaccine news was positive and investors began to look forward to a more normal economy in 2021.

Inflation expectations have risen, but are still low.

The 10-year rate of return, which is a measure of market-based inflation, was 2.20% on Tuesday, up from about 2.1% at the beginning of last week. This means that investors bet that inflation will average 2.2% over the next 10 years.

RBC’s Calvasina said that as rates rise and inflation expectations rise, investors should stick to the inflation trade.

Trade reflation is when investors bet on companies that will do well when the economy improves and reopens. This includes airlines, financial and industrial.

Calvasina also said he likes the financial sector, but some investors are under the misconception that parts of the rebate trade are already ripe.

Energy may increase by more than 15% as oil prices rise this year, but other cyclical sectors, such as materials and industry, have risen by about 2% since the beginning of 2021.

Areas of growth in technology and communications services could be used as a source of funding for the rotation because they did well, Calvasina said.

“As inflation expectations rise, you tend to see poor performance in technology, poor performance in communications services. The parts that have good trends are commodities and finance,” she added.

Jonathan Golub, chief US equity strategist at Credit Suisse, says he does not expect the technology to be too affected as rates rise. But stocks to buy in this environment are among the most “junkiest”.

“I don’t think technology will suffocate. I think the best way to look at it is the one that earns the most from an improving economy. The answer is cyclical companies … and companies that have a business problem,” he said. he said. . “You want someone in the abyss with a smaller cap, companies that have a lot of debt.”

Golub also said that the Treasury’s high yields are also positive for the market, as it represents an improving economy.

“The most exciting event in the history of the planet will not be the end of World War I, the end of World War II, it will be the reopening of the economy this summer,” he said.