Wall Street traders face a unique challenge when betting on the stock market now that the Federal Reserve has started cutting interest rates: history is no longer a guide.
The classic strategy for when rates fall is to buy stocks in sectors considered defensive because their demand is impervious to economic conditions, such as consumer staples and healthcare. Another popular play is stocks in sectors that pay high dividends, such as utilities.
The reason is that the Federal Reserve typically lowers borrowing costs to combat a weakening economy or boost an economy that has already entered a recession. During such periods, Companies in growing sectors such as technology tend to sufferBut that is not happening now.
On the contrary, the economy is growing, stock indices are hitting record highs, corporate profits are expected to continue growing, and the Federal Reserve just cut rates by half a percentage point to begin its easing cycle. There is no playbook for this.
“The fact that the Fed is opting for a big cut amid fairly loose financial conditions is a clear signal for equity investors to position themselves more offensively,” said Frank Monkam, senior portfolio manager at Antimo. “The traditional defensive stock play, like buying utilities or consumer staples, might not see much traction.”
So where do investment professionals look?
The financial sector is a good place to start, according to Walter Todd, president and chief investment officer of Greenwood Capital Associates LLC. It is buying shares of Bank of America Corp., JPMorgan Chase & Co. and regional banks such as PNC Financial Services Group Inc.
“This rate cut by the Fed should reduce their cost of funding,” he says. “They should have to pay less for deposits than they did two days ago, so that should help your net interest margin.”
David Lefkowitz, head of US equities at UBS Global Wealth Management, also likes the financial sector, as well as closely related industrial stocks. linked to a strong economy.
No history
This positioning goes against what history suggests. In the four downsizing cycles of the past three decades, investors have flocked to so-called safe havens, such as utilities, consumer staples and health care, which pay high dividends and They are popular with income investors when bond yields plummet, according to data compiled by Strategas Securities.
Six months after the first rate cut in those four cycles, the sector with the best performance was public services, with an average increase of 5.2%, according to data from StrategasThe technology sector was the worst hit, down 6.2%, while real estate, consumer discretionary and financials were also among the hardest hit groups.
Taking a broad bullish position when the Fed cuts rates and the economy holds up is a historically winning play. Since 1970, the S&P 500 index has gained an average of 21% in the year following the first rate cut in an easing cycle, provided the economy has avoided recession, according to data from Bank of America Corp.
What’s more, eight of the past nine easing cycles occurred when earnings were slowing. But earnings are now expanding, which is a boon for cyclical and large-cap stocks, Savita Subramanian wrote on Friday. BofA’s head of U.S. equity and quantitative strategy, in a note to clients.
“There is no Fed playbook: every easing cycle is different,” Subramanian wrote.
For the moment, it seems that investors are diving back into big tech stocks and other growth corners of the market. Last week, hedge funds bought up US tech stocks, media and telecommunications at the fastest pace in the past four monthsaccording to trading data from Goldman Sachs Group Inc.
‘Euphoric consumer’
Meanwhile, others are drawn to stocks that would benefit from increased spending by Americans now that interest rates are falling.
“There is going to be a euphoric consumer,” said Phil Blancato, chief executive of Ladenburg Thalmann Asset Management. “Seeing the cuts come down and seeing the opportunity to go out and get a mortgage will stimulate spending, whether it’s in the housing market, in the automotive industry or simply in end-of-year spending.”
Joe Gilbert, a portfolio manager at Integrity Asset Management, sees opportunities in mall operators such as Simon Property Group Inc, and within the industrial part of the real estate sector, including Prologis Inc.
“Many of these real estate companies have debt that they need to refinance.“We think shorter guys will definitely help them,” Gilbert said.
Utilities have also been a popular bet, but not because of their dividends. It’s their exposure to artificial intelligence in driving the development of the technology that has been attracting investors, according to Mike Bailey, director of research at Fulton Breakefield Broenniman LLC. In fact, utilities have done so well this year, Up 26% as the second best performing group in the S&P 500that their valuations may be stretching.
“It’s hard to know if we’re anticipating all the good news from public services“It feels like we’re probably not going to see another wave of outperformance for them,” Bailey says.
That said, with this wild bull run anything seems possible, at least for now. Investors have shaken off concerns about high tech valuations, elevated volatility, political uncertainty in the US and slowing hiring. Few Wall Street analysts predicted the S&P 500 would break 5,700 before the end of 2024However, the index is coming in this week at 5,703 points, after rising 20% this year, following last year’s 24% rise.
“This was the best possible scenario,” says Ladenburg’s Blancato.We have the opportunity to probably reach close to 6,000 by the end of the year.”.
