CNN UNDERSCORED - HOW TO INVEST DURING FED RATE CUTS

By: Kate Stalter, Paul Curcio, David Tony,

CNN Underscored Money -- Federal Reserve interest rate cuts can have a big effect on investor portfolios. For example, some sectors and industries historically outperform in lower-rate environments. If Fed rate cuts occur as expected during the final months of 2024, it’s important to understand how they could impact your investments.

Factors leading to Fed rate cuts

A reduction in the federal funds rate, commonly referred to as a Fed rate cut, is usually intended to support growth or manage inflation. It can also be done to stabilize financial markets. That was the case when the Fed cut rates after the September 11, 2001, terror attacks.

The Fed has a dual mandate: to promote stable prices and high employment.

“The very aggressive expansive monetary policy during the pandemic pushed unprecedented amounts of liquidity into the markets and fueled resurgent inflation,” said Robert Johnson, chairman and CEO of Economic Index Associates in New York City.

“Rate increases were needed to address inflation. Now, the Fed is loosening monetary policy to address concerns relating to its other goal of full employment,” Johnson added.

Factors driving a rate cut may include:

  • Economic slowdown: The Fed may cut rates to stimulate growth when data show that economic activity, such as hiring and consumer spending, is slowing.

  • Lower inflation: If inflation is falling and economic growth is slowing, a rate cut may help to boost demand and hiring.

  • Financial market stress: The Fed might reduce rates if there is significant market volatility or a financial crisis. This may provide liquidity and help restore investor confidence. This happened recently when the Fed slashed rates to help ease the economic impact of the Covid-19 pandemic.

How do lower interest rates impact your investments?

Lower interest rates can make certain sectors and industries more attractive, as their borrowing costs are reduced. That, in turn, may boost profitability. When earnings rise or are expected to rise, investors often sell bond holdings and put the sale proceeds into equities.

However, some bondholders also benefit from higher rates. As lower rates send prices lower for newer bonds, previously issued bonds with higher yields may perform well.

Jenny Zhan, CEO of Beyond Global Management in Houston, Texas, said that as a private lender, the default rate for her company’s current investments will be lower in a lower-rate environment, which is a benefit.

“On the other hand, we will need to work harder to source deals with the same high risk-adjusted-return profile, which we are ready to do,” she said, referring to the lower yields from newly-issued debt.

What kind of stocks should I buy when interest rates fall?

Not all equity asset classes perform the same way after an interest-rate decrease, so it’s important to identify opportunities and be ready to adjust your investment strategy.

Sectors sensitive to interest-rate cuts include technology, consumer discretionary and real estate.

Technology companies benefit from cheaper financing, and consumer discretionary companies often see an increase in revenue as lower rates increase customers’ disposable income. Real estate also tends to perform well, as reduced borrowing costs make property investments more attractive, and lead to increased demand for both residential and commercial mortgages.

Stock sectors to consider in an environment of falling interest rates include:

  • Growth stocks: Companies in traditional growth sectors like technology and biotechnology usually stand to benefit from lower borrowing costs as they fund expansion. Innovation can be capital-intensive in these industries, so lower rates tend to open up new opportunities.

  • Consumer discretionary stocks: Consumers may cut their spending on non-essential items as interest rates rise. On the other hand, discretionary spending at retail stores, cruise ship lines, hotels and restaurants, and entertainment companies often picks up as rates decline.

  • Real estate investment trusts (REITs): Real estate companies, such as REITs, benefit from reduced mortgage rates and increased property demand.

  • Utilities stocks: Utilities have significant capital requirements, and they often turn to debt. As rates decrease, debt service takes a smaller portion of revenue.

  • Materials stocks: It’s not glamorous or high-profile, but the materials sector is home to companies that supply the manufacturing and construction industries. Lower rates that spur economic activity can result in increased business spending on companies in the materials sector.

How do I make more money ahead of rate cuts?

Investors who want to organize their holdings in advance of rate cuts can tilt their portfolios toward sectors and industries that tend to outperform in a lower-rate environment.

In addition to the industries named above, assets such as preferred stocks, dividend-paying stocks and high-yield (junk) bonds may also outpace other investments as rates fall.

  • Preferred shares: These are equities that have a fixed dividend. When interest rates decline, preferreds frequently have higher yields than bonds and shares of common stock.

  • Dividend stocks: Companies with a track record of increasing their dividends may be a draw after a rate cut, as investors turn to payouts that may be higher than those of fixed-rate bonds.

  • High-yield savings accounts: As the interest on regular savings accounts dwindles after a rate cut, high-yield savings accounts, which are also sensitive to changes in the fed funds rates but offer higher interest rates, become a more attractive option.

Potential future trends in Fed rate cuts

Some investment advisors and market analysts believe the Fed will cut rates over several quarters following the series of increases that began in March 2022.

That could benefit the wider market. For example, stocks buoying broad market performance have included the so-called Magnificent 7:

  • Apple (AAPL)

  • Microsoft (MSFT)

  • Amazon (AMZN)

  • Alphabet (GOOGL)

  • Meta Platforms (META)

  • Nvidia (NVDA)

  • Tesla (TSLA)

While a rate cut would likely benefit tech stocks, it would also boost other sectors and industries. That means market breadth — the ratio of rising stocks to falling stocks — could improve, which would be a sign of wider strength that’s not concentrated in just a few stocks.

“Assuming the Fed does cut rates, it will likely be the start of a multi-quarter, rate-cutting cycle, which could drive investor interest away from the Magnificent 7 towards the rest of the market, which has been quietly languishing in a bear market since the 2021 peak,” said David Lundgren, chief market strategist at New York City-based Stirlingshire Investments.

About Stirlingshire Investments 
Stirlingshire Investments, Inc. is a New York–based Fintech building technology designed to provide advisors and clients with a flexible, wholistic platform to support long-term growth in a rapidly changing industry. The firm combines independence with leading edge institutional-level infrastructure across compliance, technology, operations, and strategic support. Advisory Services are offered through Stirlingshire RIA LLC, an Investment Adviser registered with the U.S. Securities and Exchange Commission. Brokerage Services are offered through Stirlingshire BD LLC, a Broker-Dealer registered with the SEC and a member of the Financial Industry Regulatory Authority (FINRA) and the Securities Investor Protection Corporation.  

For more information, visit www.stirlingshire.com.  

Media Contact: 

Nicole Cox 
Chief of Staff 
Stirlingshire Investments
nicole@stirlingshire.com
647-500-2763