The Federal Reserve rate hike has finally kicked in, with FOMC officials on Dec. 14 raising the target for short-term interest rates by 0.25%, a much-anticipated move that has contributed to a wave of market optimism. Along with a strong dollar, and expectations of job creation and deregulation, there is a spirit of free market enterprise as businesses set their sights on bigger profit margins and fewer restrictions.

The economic forecast looks rosy for next year, and certain sectors, such as financials and especially the regional banks, will markedly benefit from the higher rate. But identifying opportunities for tactical trades with exchange-traded funds will, of course, still depend heavily on President-elect Donald Trump and the success of his policies, impacting everything from health care and interest rates to biotech and emerging markets. 

Until then, moves in U.S. currency, small-cap performance, expectations of administration policies and other market shifts are presenting potential openings for bulls and bears alike as we head into the new year.

Here’s where we see the opportunities.

Financials
Even before the Fed’s Dec. 14 rate hike, the financial sector was pricing in a higher rate regime. Financials, specifically regional banks, benefit from a higher rate through an increase in net margins. Bank stocks got more of a boost as Fed Chair Janet Yellen not only raised the rate by 25 basis points, but also signaled officials expect three quarter-point rate increases next year, up from two mentioned in September.

Trump’s support for deregulation and lower taxes are expected to add to the good news for this sector. A less regulated market is a boon to financials, as lighter regulation reduces compliance and operational costs, and increases the creation of client-tailored products, such as structured products, as their restrictions ease. 

Biotech
Biotech will be a sector to watch in the short term for volatility traders. The healthcare sector was heavily impacted by Democratic candidate Hillary Clinton’s focus on curtailing the biotech drug pricing structure. Biotech now looks ready to play catch-up with sector stocks spiking nearly 10% a day after Trump’s election. As part of the interest rate-insensitive healthcare sector, biotech should benefit from the current market shift away from defensive, rate-sensitive sectors.

Generally, the recent GOP win is also a win for highly regulated industries, as deregulation will relieve some of their restrictions and bode well for these stocks.

Interest Rates
With the expectation for a more aggressive rate-increase trend in the new year, we see interest rate-sensitive sectors continuing to underperform. Although utilities, real estate investment trusts (REITs) and staples have underperformed the market in the second half of the year as certainty of a rate rise grew, all of these sectors have rallied since the Fed’s increase.

Trump campaigned on a major push for fiscal spending, supporting stimulus in the form of a major infrastructure infusion. A fiscal expansion theme supports a curve steepening resulting in rate rise expectation.

USD and Rates
The U.S. dollar and rates promises to continue to be a hot topic next year. The rise in U.S. currency has been unprecedented. With the 0.25% rate hike from the Fed, and a promise for up to three more hikes, the dollar is expected to rise through 2017. The greenback reached 103.56, a level we haven’t seen in 14 years. The market continues to expect a big shift in fiscal policy with the incoming administration, which bodes well for plays on rate hikes and a strong dollar.

As mentioned above, this is a positive development for financials, but creates a headwind for emerging markets, particularly U.S. dollar-denominated EM debt countries.

For traders, potential plays are going long on USD, the U.S. 10-year Treasury, regional banks, or short on gold, utilities, REITs or staples.

Small Cap & Health
The post-election performance of small-cap stocks relative to large-cap equities has been almost outstanding, with small-cap healthcare biotech stocks a particularly strong example having risen almost 10% since the election compared to 2% for large caps. Trump’s push for deregulation appears to have increased expectations of new M&A activity and growth among smaller firms, which would see their operational costs go down. Biotech stocks have continued to gain on expectations that Trump’s election means less government drug price scrutiny.

For traders, potential plays would be going long on the Russell 2000 Index and biotech.

EEM Debt
The strengthening U.S. dollar continues to send shockwaves throughout the emerging market complex, with some theorizing that Trump has burst the bond bubble, causing a sharp selloff in the sector. The iShares Emerging Market Index ETF, EEM, was down 7% after the election, with trends heading toward oversold levels, after experiencing massive inflows a few months ago.

Emerging markets climbed 2.99% earlier in the month and are up 13.24% year-to-date. Emerging market outperformance lately has been led by oil and commodity exporting countries. As oil continues to climb above $50, countries such as Russia and China have outperformed the rest, while countries with large dollar denominated debt, such as Brazil and Mexico, have struggled. Oil and the dollar will continue to determine the path of emerging markets in the short term. 

For traders, a potential play is going short on EEM.

See ThinkAdvisor’s Outlook 2017 landing page for more insights for advisors on the economy and markets in 2017.