Central banks in the US and Canada have been fighting high inflation by increasing key interest rates. The Bank of Canada’s efforts to slow down economic activity to reduce inflationary pressure can help the economy. That said, higher borrowing costs are a double-edged sword.
The higher the interest rates become, the pricier everything bought on credit gets. High interest rate environments also negatively impact stock market returns. Publicly traded companies rely on taking on debt loads to finance operations. With borrowing costs higher, profit margins reduce across all industries.
However, not every TSX stock is a risky bet in a high interest rate environment. Granted, higher borrowing costs will impact the bottom line. Still, some companies have the kind of stable business models and capitalization necessary to come out stronger on the other side.
Today, I will discuss two high-quality TSX stocks you can consider investing in to protect your portfolio from the impact of high interest rates.
Fortis
Fortis Inc. (TSX:FTS) is a mainstay in many Canadian stock market investor portfolios. The $27.8 billion market capitalization utility holdings company has several reasons to be a top pick for any self-directed investment portfolio.
Fortis owns and operates several natural gas and electricity utility businesses located throughout the US, the Caribbean, Central America, and Canada. Operating in highly rate-regulated environments, Fortis relies on long-term contracted assets for most of its revenue.
These two factors combined with the essential nature of its services virtually guarantee predictable cash flows for Fortis stock. While higher interest rates negatively impact its margins, Fortis stock has still managed to grow its earnings. It is a Canadian Dividend Aristocrat approaching 50 years of dividend growth.
As of this writing, Fortis stock trades for $57.42 per share, boasting a 4% dividend yield. While it might not benefit from higher interest rates, Fortis stock is an asset that can continue delivering shareholders their returns through such market conditions.
Royal Bank of Canada
Royal Bank of Canada (TSX:RY) is a stock that can benefit when interest rates are higher. The $171.7 billion market capitalization financial services company is the largest bank in Canada. Boasting over 17 million customers worldwide, it is a massive lender.
Banks provide loans to various borrowers, from individuals to companies. Financial institutions charge interest on loans, the same interest rates influenced by the Bank of Canada’s key interest rates.
The higher the interest rates are, the more RBC and its peers can charge. That said, higher interest rates make borrowing difficult for consumers. Rate hikes can cause treasury holdings for banks to decline. The situation caused similar problems for several US banks. However, the Royal Bank of Canada operates in a strictly regulated market, protecting it better than its peers across the border.
As of this writing, Royal Bank of Canada stock trades for $123.89 per share and boasts a 4.36% dividend yield. Between its stable business model and long-term growth prospects, it can be an excellent investment to hold right now.
Foolish takeaway
Soaring interest rates are a concern for businesses with substantial variable debt. Rising interest rates can cause market volatility before things can begin improving. However, well-capitalized companies with stable business models providing essential services are well-equipped to weather the storm. Additionally, higher interest rates can cause net interest margins for lenders to soar.
To these ends, Fortis stock and Royal Bank of Canada stock can be defensive assets when interest rates are high.
