Investors should consider rethinking their investment playbook following the Federal Reserve's rate hike as expectations for a higher-for-longer rate environment intensify, according to Bank of America. Last week, the Federal Reserve increased interest rates by 25 basis points – its first interest rate hike in more than three years – bringing the overnight funds rate to a target range of 3.75%-4%. The hike was widely expected as Fed Chairman Kevin Warsh has been vocal about tackling stubborn inflation to achieve better price stability in the economy. Bank of America expects two more 25 basis point hikes this year. Long-term yields have risen to almost 20-year highs. The benchmark 10-year Treasury spiked more than 14 basis points to 5.116% on Wednesday. The increase was its largest one-day move in nearly 18 months, and its being driving by several factors: hawkish commentary from a top Federal Reserve official , high oil prices and robust economic activity. Higher yields tend to pose competition for stocks has investors may prefer allocating to relatively risk-free and higher yielding bonds rather than risk-on stocks. However, during Fed hiking cycles, Bank of America argued that quality stocks – those that have strong balance sheets and consistent cash flow – and value stocks – which are temporarily out of favor and are trading at a lower valuation – have been the best performing groups in the Russell 2000. BofA said quality stocks should "continue to lead given the likelihood of more Fed hikes," while value stocks have a chance to accelerate as profits grow. The bank included a screen of Russell 2000 stocks that rank well on factors that have historically outperformed during hiking cycles including Madison Square Garden Entertainment, Peloton and Puerto Rico's First Bancorp . It said these companies have proven they can generate strong revenue, earnings and cashflow despite the pressure of higher interest rates on their businesses. BofA said Madison Square Garden should perform well in a higher rate environment given the entertainment giant ranks highly on cash flow returns. Analysts have a buy rating on the stock. Madison Square Garden's stock has climbed more than 45% so far this year. Likewise, First Bancorp should outperform in a rate hiking cycle given that banks tend to benefit from higher rates since they earn more on loans. In a similar light, the overall financial sector is a beneficiary of higher rates since they can charge more on mortgages, car loans and business debt. The Puerto Rico-based bank has gained 30% so far this year. Consumer discretionary name Peloton should also be poised to perform well as it's top ranked on free cash flow and return on invested capital. The connected fitness company is in the midst of a turnaround effort and recently unveiled new treadmills, an AI-powered personal training assistant and new distribution channels. Peloton shares have fallen more than 20% year to date.
