Why do some sectors benefit from higher interest rates?

Interest rates are very influential in determining the prices of stocks and shares. Generally, theory indicates that returns on debt increase as the costs incurred by borrowers rise. This can cause stock prices to drop as that cost may increase business’ future cash outflows, reducing their present values.

However, financials will directly profit from rising returns on debt as net interest margins will increase while the associated costs will stay relatively level. This is particularly applicable to banks that conduct most of their business through traditional banking activities such as mortgage lending, where an incremental change to interest rates can have a significant effect on the average cost of monthly mortgage payments.

Alternatively, the uncertainty induced by falling share prices from higher interest rates may increase demand for fund managers effective in mitigating market losses, as well as benefit companies with an interest in gold prices — a popular safe haven for capital.

Why I would buy Virgin Money UK

Back in May this year, when the Bank of England raised the base rate to 1.0%, Virgin Money (LSE: VMUK) was able to increase its net interest margin to approximately 1.85% for the year, up from 1.75%. I expect this margin to increase further, which is very exciting for a bank with 80.43% of gross customer loans on their balance sheet being mortgages according to their 2022 interim report. In comparison, mortgages make up 56.21% of NatWest’s lending in the same report.

However, up until now, interest rates on saving have remained low despite base rate increases. If banks like Virgin Money start to compete on higher savings rates, this will start to put pressure on net interest margins and profitability again. However, Virgin Money does not have a notably high exposure to interest-bearing liabilities.

Why I would buy Legal & General

Legal & General (LSE:LGEN) is, undoubtedly, a big name in investment management, pensions, and protection in the UK. Since 2014, Legal & General has not experienced much growth in its share price. L&G currently has around £1.3trn in assets under management and is the UK’s market leader in pension annuities.

A large portion of L&G’s pension product funds will be invested into bonds to generate retirement income for clients. Previously, the low interest rate environment will have been hindering L&G in terms of pre-tax profits since lower bond yields require more funds invested to generate the same amount of income. Clearly rising, interest rates are already relieving pressure on L&G, with its 2022 interim report showing a 212% increase in its solvency ratio.

Quality and a strengthening balance sheet certainly make L&G a potentially solid choice for my portfolio in an uncertain, contractionary market.

When CYBG completed the merger of its peer, Virgin Money (LSE: VMUK), in the middle of 2018, investors pushed shares in the enlarged lender up to an all-time high of more than 350p.

However, the company has come under pressure since the group completed the deal. The stock has slumped 50% from this all-time high, as the bank has failed to live up to expectations. 

Significant challenges

In fairness, there have been some significant challenges for the group to overcome along the way. The integration process was a bit trickier than initially expected and then the coronavirus pandemic arrived. That caused significant disruption across the enterprise when it should have been concentrating on expanding its bigger footprint. 

After two years of disruption, it looks to me as if this business is now getting back on track. According to the company’s latest trading update, covering the three-month period to the end of December, the lender has made solid progress in refocusing its business model away from low-cost credit.

The overall net interest margin, which measures the gap between the cost of the bank’s cash (usually savings deposits) and the amount it charges borrowers, rose to 1.77% from 1.70% in the previous quarter. 

While overall lending balances declined, the company reported an increase in unsecured lending. This is typically credit card lending, which has a significantly higher interest rate than products such as mortgages. 

A cheap UK share in transition 

Virgin Money is in the middle of a significant transition. The company is trying to improve its digital proposition, reduce costs and increase options for consumers. It is also focusing on customer service rather than the race to the bottom that has persisted across the UK banking industry in recent years. 

This strategy is not risk-free. It assumes consumers are willing to pay a bit more for better service. That is not guaranteed in the banking industry.

Meanwhile, some of the company’s peers have considerably deeper pockets and can offer much better deals. This could push customers away from the business in the long run, holding back growth. 

Still, looking at this cheap UK share, I think its depressed valuation more than makes up for these potential risks. Indeed, at the time of writing, the stock is trading at a forward price-to-earnings (P/E) ratio of just 6.5 and a price-to-book (P/B) value of 0.5.

I believe these metrics fail to take into account the company’s potential. In fact, I think the market is focusing too much on what the company was, rather than what it can be as the UK economy returns to growth, interest rates rise and the lender’s growth strategy moves forward.

With these tailwinds behind it, I reckon the market may re-rate the shares to a sector-average multiple. 

Considering many of the company’s peers are trading at a double-digit P/E multiple and a book value of at least one, these figures could indicate that the stock could double from current levels.

Based on this potential, I would be happy to buy the shares for my portfolio today.

In particular, I am interested in companies that may be lagging behind the rest of the market in terms of their recovery. I think these stocks could have tremendous potential in 2022 as the world continues to rebuild after the pandemic. 

As such, here are three FTSE 250 shares I would buy for my portfolio in 2022 and beyond. 

Recovery shares to buy

Over the past two years, the travel and tourism sector has experienced one of the harshest environments on record. Unfortunately, it does not look as if the industry will be able to move on from the pandemic anytime soon. 

However, I would like to build some exposure to the sector as a way to invest in the recovery. That is why I would acquire airline Wizz Air (LSE: WIZZ) for my portfolio. 

Of all the companies in the travel and tourism sector, I think this business is best-positioned for the recovery. It entered the crisis with a strong balance sheet stuffed with cash. It also has a relatively low-cost base compared to peers. As other airlines rushed to cut costs and reduce cash outflow during the pandemic, Wizz has had a higher level of financial flexibility. 

These qualities also suggest that the corporation can capitalise on the economic recovery over the next few years. Indeed, management is so optimistic about the outlook for the group the company recently placed a massive order for new planes to expand its fleet significantly. These new planes will help the business meet demand on the new routes it plans to launch.

Passenger demand has already recovered from pandemic lows. According to the group’s latest trading update, in November, Wizz carried 2,172,000 passengers at a load factor of 76.1%. 

Despite the group’s progress, a couple of challenges could hold back its recovery. These include rising fuel costs and competition in its sector. Both of these headwinds could weigh on the company’s bounce back over the next couple of years. 

FTSE 250 challenger

Virgin Money‘s (LSE: VMUK) business model is interesting. The bank is trying to take on the financial sector giants by offering something different. The group focuses on providing a high level of customer service and an engaging electronic offer to attract younger, digital-savvy consumers. 

For example, the group is developing a digital wallet with buy-now-pay-later capability. By spending through the wallet, consumers will also have the potential to earn and utilise ‘Virgin Red’ points. 

This is a consumer reward club operated by the Virgin Group allowing consumers to choose from 150 different experiences they can buy with their points. 

The bank’s ability to leverage other parts of the Virgin empire to attract consumers is also unique. Rivals do not have the reputation or footprint to copy this approach. 

Merger costs 

When it comes to the challenger bank’s finances, the figures are a bit misleading at the moment. After Virgin Money and fellow challenger CYBG merged several years ago, the duo united under the Virgin banner in 2019. Since then, the group has continued to work through the integration process, although this was disrupted by the pandemic.

The combination of the additional costs from the merger as well as rising loan losses in the pandemic pushed the group into the red. 

It looks as if these pressures are now starting to dissipate. This suggests the group’s best days are now ahead. This is the reason why I would buy the stock in 2022. Management plans to reduce costs significantly over the next two years and substantially increase profitability. These developments, coupled with potentially higher interest rates, could help the organisation produce substantial returns for shareholders. 

That said, rising wages could offset some of the company’s cost-cutting initiatives. There is also no guarantee interest rates will increase from current lows, and there is always the threat of additional regulations and taxes, which are the bane of the banking industry. 

FTSE 250 growth play

One of the easiest ways to build exposure to the global economic recovery, in my opinion, is to buy a FTSE 250 recruiter. Hays (LSE: HAS) fits the bill perfectly. And with a large global footprint, it is already riding the coattails of the global economic recovery. 

According to its latest trading update, which covered the period to the end of September, 12 of the regions in which it operates produced record net fees, including the USA and China. 

Overall, fees across the group increased 41% on a like-for-like basis. To meet the rising demand for its services, the company has been investing heavily to recruit and train new staff as well as opening new offices.

The number of staff employed by the company has increased 19%, but despite this growth, the average productivity per consultant remained at record levels in the quarter to the end of September. 

Put simply, it looks as if the need for the group’s services is exploding. And it cannot recruit enough staff to meet this growing demand. That is a great position to be in, especially as the economic recovery is only really just getting started. 

Despite this growth potential, I will be keeping an eye on the economic environment to see if it deteriorates. Recruiters are usually the first to feel the pain in a downturn. Therefore, if the recovery suddenly starts to splutter, Hays may suffer more than most.

UK shares

I’m primarily looking for shares to buy that could benefit from a UK economic recovery over the next few years. 

The property industry is one of the sectors that’s seen the most growth over the past 18 months and may continue to register strong growth. That’s why I’d acquire LSL Property Services (LSE: LSL). 

This property services group is active in all sections of the industry. It provides valuation services for mortgage providers, mortgage broking, and estate agency services. Thanks to this diversification across the industry, growth has rocketed over the past year. For the six months to the end of June, revenue increased 45%, while group operating profit increased 647% to £26.7m. 

The property market’s experienced a boom over the past year, thanks in part to the government stamp duty holiday. It seems unlikely that property prices will continue to increase at a double-digit annual percentage rate. Still, even if growth returns to normal levels, I reckon LSL will continue to reap the benefits. 

This is why the company features on my list of the best UK shares to buy now. It also has a strong balance sheet with £17m of net cash and is distributing profits to investors. The stock currently yields just under 1%, although I wouldn’t rule out further cash returns if profits continue to grow. 

Challenges that could hold back group growth include higher interest rates, which could hurt property market transactions. A lack of qualified staff may also contribute to a growth slowdown.

Growth shares to buy

Another company that features on my list of the best UK shares to buy is Virgin Money (LSE: VMUK). I’d buy this stock because I want to have some exposure to the financial sector over the next few years.

I think this sector will benefit more than most in the UK economic recovery, as it looks as if interest rates increase next year. That could be positive for bank margins. 

Virgin’s better positioned than other lenders, in my opinion, because the group has already made substantial progress with its digital strategy. It’s planning further changes over the next year. These include more branch closures, greater automation and a hybrid working model.

While these changes will incur substantial restructuring costs, they should lower overall operating costs and improve group flexibility when complete. The combination of organic growth and a streamlined operating model should act as a dual tailwind for Virgin Money. 

Challenges it could face as we advance include higher costs and additional regulation, both of which could hold back the group’s growth rate. 

I think all of the three companies outlined below have significant growth potential, which is why I would buy them for my portfolio today. 

Growth potential

The first company on my list is the engineering business Weir (LSE: WEIR). The group produces engineering equipment for the mining and oil and gas sectors, and it is currently benefiting from an increase in commodity prices. As prices rise, miners have more cash to spend on new and existing projects. This means more orders for Weir. 

According to its interim results for the six months to the end of June, orders during the period increased 17% and adjusted operating profit jumped 12%. 

I think commodity prices will continue to boom as demand for critical resources expands. Governments are spending significant sums on infrastructure projects worldwide, and the resources for these projects will need to come from somewhere. Weir may continue to benefit as miners grow to meet this demand. 

That is the main reason why I would buy this stock for my portfolio of UK shares. However, I should note that the commodities industry is incredibly volatile. If prices slump, producers could slash orders. That would be terrible news for Weir. 

Recovery play 

In my opinion, casino operator Rank Group (LSE: RNK) is an attractive pandemic recovery play. During the pandemic, the firm’s casinos were forced to close. The company survived by boosting the size of its online business, which provided much-needed cash flow for the organisation. 

Thanks to its online business, the group was in a solid position to stage a recovery as the economy reopened. And since that reopening, in the 13 weeks to 15 August, sales have rebounded. During the period, they were just 19% below the same period in 2019. With average weekly revenues of £5.7m, the firm is comfortably above its cash break-even level of £4.4m. 

I think these figures imply the company is set for a strong recovery in the weeks and months ahead. That is why I would buy the stock for my portfolio of UK growth shares. 

Issues that may destabilise the group’s growth include the risk of another lockdown, and additional regulations, which may increase costs and reduce customer spending. 

Basket of UK shares 

The final company I would buy as a growth investment is Virgin Money UK (LSE: VMUK). 

I think this challenger bank has tremendous potential. Its growth slowed last year, mainly due to the pandemic, but management is targeting expansion this year. The company is trying to grow in personal lending and mortgages, and it is targeting higher interest loans to improve profit margins. 

It is also investing heavily in its digital capability, and this is already yielding results. Over 100k customers have signed up for online products, and it is working with other fintech companies to improve the offering for consumers. 

As the bank pushes ahead with its growth plans, I would buy the stock for my portfolio of UK shares. 

However, this equity might not be suitable for all investors. Banks can be challenging to understand, and if there is a sudden economic downturn, this sector is usually the first to feel the pain. 

With that in mind, here are three shares I’d buy right now as markets plunge. 

Stock market crash buys 

I plan to focus on buying economic recovery plays, as I think these companies have the most potential as we advance.

With that in mind, I would add Virgin Money (LSE: VMUK) to my portfolio today. I think the challenger bank should see rapid growth over the next few years as the economic recovery gains traction. Its latest results show the group is already heading in the right direction. 

At the beginning of May, Virgin Money said fiscal first-half pre-tax profits came in at £245m from £120m a year ago. 

Based on City growth projections, the stock is currently trading at a forward price-to-earnings (P/E) ratio of 11.4. While I’m conscious these are just projections at this stage, I think that looks cheap. And that’s why I’d buy the bank amid the stock market crash. 

Still, this might not be suitable for all investors. The pandemic is not over yet, and another wave could cause yet more economic pain. That could have a devastating impact on Virgin’s recovery. 

Fighting fit 

Like Virgin, the Gym Group (LSE: GYM) has taken a big hit to profits over the past year. However, it’s now also looking forward to a period of rapid growth. 

Last year the group reported a pre-tax loss of £47.2m as revenues plunged from £153m in 2019 to £80m. Unsurprisingly, the firm also eliminated its dividend to investors. 

Nevertheless, putting a bad year behind it, management is optimistic about the future. The company planned to open three new gyms in April and one in May. It’s also beginning constructing another four gyms as it pushes to drive membership back to, and possibly above, pre-pandemic levels. 

However, there is one considerable risk hanging over the company, and that’s debt. It had to tap its lenders for extra cash to keep the lights on last year. While there is room for further borrowing, another lockdown could stretch the firm to its limits. 

Despite this risk, I’d buy the company in the stock market crash as an economic recovery play. 

Reopening play 

The final equity I’d buy amid the stock market crash is Hollywood Bowl (LSE: BOWL). 

The owner of bowling alleys around the UK reported a near-total decline in profitability for its financial year ending 30 September 2020. Pre-tax profit fell from £28m to £1.2m. 

But like Gym, the company is also looking to put this performance behind it. The business recently raised £30m from shareholders to “invest in new centre opening opportunities” and refresh its existing facilities. 

As the UK economy reopens, I think the company could see a significant uptick in business, and that’s why I’d buy the stock as a recovery play amid the stock market crash. 

The primary risk the company now faces is the potential for another lockdown, which would decimate sales once again and could throw its future into question. Overexpansion may also result in losses. 

This UK banking share sank to two-week lows around 183p per share earlier in midweek trading. It’s recovered some ground to 189p, as I write, but remains 5% lower from Tuesday’s close.

Back in profit

Virgin Money’s share price has fallen following the release of half-year trading numbers. But don’t think this reflects some chilly news coming out of the FTSE 250 share. Instead, the company advised of a sharp improvement in trading conditions and painted a cautiously positive picture looking ahead.

Virgin Money’s share price fall represents nothing more than healthy profit taking following strong recent gains. The bank had risen around 50% in value in 2021 prior to today’s release and by 169% over the previous 12 months.

Virgin Money said today it bounced back to pre-tax profit on a statutory basis. This is thanks to a sharp drop in impairment charges, it said. Profit clocked in at £72m for the six months to March, improving from the £7m loss recorded a year earlier.

On an underlying basis, meanwhile, Virgin Money’s pre-tax profit more than doubled year-on-year to £245m.

Impairment charges crumble

Income at Virgin Money fell 9% between October and March, to £743m, caused by the introduction of additional Covid-19 lockdowns. But impairment charges collapsed from the same period a year earlier, coming in much lower than expected too. At £38m, this was much better than charges of £232m the bank had booked previously.

In other news, Virgin Money’s net interest margin slipped to 1.56% in the six months to March. This was slightly worse than the 1.62% the firm punched out in the same 2019/2020 period.

Virgin Money looks ahead with confidence

Chief executive David Duffy was positive-if-careful when commenting about Virgin Money’s prospects. “We are cautiously optimistic about the improving outlook as the impact of the vaccination programme in the UK delivers positive revisions to economic expectations,” he said.

“We’re continuing to manage through what is still an uncertain economic backdrop, but the bank is well placed, with a strong balance sheet, and through ongoing strategic delivery we have a clear path to long-term, improved sustainable return,” Duffy added. He also praised the “significant strategic progress” Virgin Money has made to transform itself “into a leading digital bank.”

City analysts think Virgin Money will record earnings of 14.9p per share in the fiscal year to September. This compares to losses of 15.3p recorded in the previous financial period and leaves the bank trading on a forward price-to-earnings (P/E) ratio of 13 times.

With that in mind, here are three companies I’d buy for my portfolio today. 

FTSE 250 stocks to buy 

I think some of the best investments on the market right now could be recovery plays. A great example is ITV (LSE: ITV). I own shares in this business because I think it’s deeply undervalued. 

Based on current analyst projections, the stock is trading at a forward P/E multiple of just 11.4. That’s below the company’s long-term average ratio of around 15. Of course, these are just estimates at this stage and the company isn’t guaranteed to hit these targets. 

Still, I think the outlook for ITV has improved dramatically over the past few months. Advertising revenue has recovered, and its studio business is reporting inquiries from companies all over the world. 

That said, the group is still fighting for market share with the large American streaming companies. It needs to keep on spending to try and maintain its market share. This could hold back growth in the long run but, as an FTSE 250 recovery play, I’d buy more of this business. 

Construction growth

Initial indications show that the construction industry is already roaring back to health. This implies the outlook for companies like Morgan Sindall (LSE: MGNS) is, well, looking up. 

Despite the brightening outlook for these businesses, the stock is still trading at a forward P/E of 11.3. That looks too cheap to me, considering the company’s potential in the near term.

Construction is a relatively cyclical business. So, if the economic recovery doesn’t live up to expectations, Morgan may suffer more than most. That’s something investors need to be aware of in the current market climate. The company’s tight profit margins also means it has little room for manoeuvre if costs rise significantly. 

While these risks and challenges are worth keeping an eye on, I’d buy the stock for my FTSE 250 recovery shares portfolio. 

Economic growth

Another industry that could benefit significantly from improving economic growth over the next few quarters is the financial sector. One of my top FTSE 250 picks in this sector is Virgin Money UK (LSE: VMUK). 

Like most financial institutions, this challenger bank has suffered from rising loan losses and low interest rates throughout the pandemic. Unfortunately, it doesn’t look as if interest rates are going to rise anytime soon. This is the biggest challenge the lender faces right now. 

However, with the stock trading at a 2022 P/E of less than nine and a price-to-book value of less than 0.6, I think these figures look incredibly cheap. Which is why I’d add the stock to my portfolio of recovery shares today.

As the UK economy begins to awake from its slumber, I think Virgin should benefit from increased consumer confidence, leading to more borrowing and spending. 

Balfour Beatty

Balfour Beatty (LSE: BBY) is the first UK share I want to buy next month. Prior to the pandemic, which shut down most construction across the UK, the industry was contributing approximately £140 billion pounds to the economy.

Balfour Beatty leads the pack in British construction and has the most to gain from the eventual reopening of the country. As governmental infrastructure plans resume, I think that UK construction stocks will receive a big boost for years to come, beginning with easings in April. Infrastructure never stops, and the company has the resources to weather any hardship, which leads me to believe that Balfour Beatty’s share price will be the biggest beneficiary when construction sites reopen.

Of course, there is always the looming threat of a global recession thanks to mounting Covid-19-induced debt, which could see the construction sector as one of the worst-hit, dramatically hurting Balfour Beatty.

Playtech

Of all the top UK shares to buy in April, I wouldn’t have normally thought of a gaming giant, yet I’m itching to add Playtech (LSE: PTEC) to my portfolio before summer.

This is a risky ‘bet’ for me (forgive the pun). A 10.6% decline in B2B revenue in 2020 weighed on Playtech and contributed to a group-wide 25% decline in revenues to €1.07 billion for the year, meaning that it really has a lot of ground to make up if it’s going to stand a chance at seeing its share price grow.

But I think that the gambling software developer will be the biggest winner when fans return to events such as the Olympics and UEFA European Championship. I believe that the return of fans, albeit in a restricted fashion, will see an upsurge in gambling as home-stayers attempt to up the stakes. Especially those fans who have extra disposable income that would have otherwise been spent on social events.

Even though Playtech’s share price has risen more than 130% in the past 12 months, it is still a long way off of its 2017 highs, which makes its current price cheap for me (and my Foolish colleague Jabran Khan agrees).

Virgin Money UK

Much like gamblers, I believe that banks will be among the biggest winners from increased disposable income, making Virgin Money UK (LSE: VMUK) my final top UK share to buy in April.

Banks were hit hard in 2020 as businesses everywhere closed their doors, but with an economic reopening and improved outlook on the horizon, I foresee these losses receding, which should see Virgin Money stage a recovery over the coming years. I am hoping that pent-up frustration from being locked down will lead to increased borrowing as people jet off on holidays and other experiences, beginning this summer, which will only benefit the company.

Of course, banks are still very risky during a pandemic, and although Virgin Money is among my top British shares to buy in April, ultra-low interest rates will put massive pressure on already depressed profit margins, thus increasing my risk in such a position.

With that in mind, here are my favourite FTSE 250 stocks I’d buy right now. I think each of these businesses has a bright and improving outlook. I reckon they’ll continue to grow no matter what happens in the rest of the market. 

Looking past the stock market rally 

Investors have been buying stocks recently as the global vaccine rollout has inspired confidence that the global economy will return to growth later this year. 

Unfortunately, it’s impossible to say if this’ll be the case at this early stage. The global economy faces many risks at present. Anything could happen over the next few months, which would destabilise the recovery. 

Nevertheless, I believe buying high-quality firms is likely to be a successful strategy in the long run. Of course, nothing is ever guaranteed when it comes to investing. But, by focusing on companies with strong balance sheets and competitive advantages, I think I can swing the odds of success in my favour.

Two FTSE 250 businesses, in particular, tick these boxes.

Greggs and Grainger are two very different firms. One is a retail bakery, best known for its sausage rolls, and the other is a large residential landlord. Despite these differences, I think both businesses have strong balance sheets and, more importantly, strong competitive advantages in terms of their brand and scale. This doesn’t mean these stocks are without risks. Greggs’ sales have suffered significantly from rolling lockdowns.

This could continue if the virus remains a threat. Rising wages and ingredient costs may also put pressure on the FTSE 250 business. Meanwhile, Grainger is at risk from regulatory changes and rising interest rates, which could destabilise its business model. 

Still, I’d buy both of these businesses to capitalise on the stock market rally and take part in their future growth potential. 

FTSE 250 financial services

One way to play the UK economic recovery is to buy financial services stocks. One option is Virgin Money.  In my opinion, this challenger bank is one of the most exciting financial businesses in the country. It has the size and scale to compete with larger financial groups, and the Virgin brand is known the world over. 

Despite its opportunities, the company does face challenges. Low interest rates have become a persistent challenge for lenders over the past decade. It doesn’t look as if this is going to change anytime soon. What’s more, the lender has announced it will have to write off £726m of loans due to the pandemic. This figure could increase as the true impact of the crisis becomes known. 

Despite these risks, I’m incredibly excited about the company’s future. That’s why I’d buy the stock for my portfolio today.