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Rate-Sensitive Stocks Cheer Fed Meet Outcome: 5 Solid Buys

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Federal Reserve officials supported a June rate hike but weren’t in a rush to tighten rates aggressively this year. They were not certain that inflation will stay around 2% for long and suggested that even higher inflation might not result in faster rate hikes.

A slower rise in interest rates boosted rate-sensitive sectors. Thus, investing in home builders and utility players from the Fed’s latest decision seems judicious.

June Rate Hike in the Cards

Minutes from the Fed’s May 2 meeting showed that most of the policymakers have agreed that a strong economic outlook warranted a rate hike “soon.” Traders in the federal funds futures market are pricing in a 90% chance of a June rate hike. Fed officials kept the target range for the benchmark overnight lending rate unchanged at 1.5% to 1.75% in early May after raising rates in March.

The Fed said in the minutes that “most participants judged that if incoming information broadly confirmed their current economic outlook, it would likely soon be appropriate for the committee to take another step in removing policy accommodation.”

Fed to Go Easy With Rate Hikes This Year

But, the policymaking arm of the Fed seems to remain flexible on its inflation targets, indicating that it is not in a hurry to bump up rates faster than planned. The officials also mentioned that it won’t be a problem if prices of essential commodities went past the Fed’s target range of 2% and concluded that rate hikes will be gradual this year.

The odds of three more rate hikes this year instead of two declined after the minutes. The CME’s FedWatch tool showed that the Fed funds futures market sees less than a 40% chance of a fourth rate hike this year.

Fed’s Calm About Inflation

The minutes, in fact, said that “it was premature to conclude that inflation would remain at levels around 2%, especially after several years in which inflation had persistently run below the Fed’s 2% objective.”

This showed that most of the Fed officials were not convinced that inflation will remain at elevated levels for long even though the Fed’s preferred indicator reached 2% in March. After all, it has taken such a long time for inflation to get there, with so many fits and starts. It was only a “few” officials who thought that inflation may go past the 2% mark.

Rate-Sensitive Sectors Gain

With the Fed minutes reassuring investors that the central bank won’t be too aggressive in hiking rates, shares of rate-sensitive utilities and real estate scaled north. Both the Utilities Select Sector SPDR ETF (XLU) and Real Estate Select Sector SPDR (XLRE) were top-performing sectors on May 23, raking in 0.9% and 0.8%, respectively.

Utilities are capital-intensive businesses and the funds generated from internal sources are not always sufficient to meet their requirements. Hence, these companies have high levels of debt. Low interest rates will help them pay off debts and book profits.

But, higher interest rates along with an increase in the debt level, for that matter a steep debt/equity ratio, impact the credit ratings of these utility operators. If the credit ratings go down, a company will find it difficult to borrow funds from the markets at reasonable rates, leading to a rise in cost of operations.

Rate hikes are also a dampener to real estate activities. After all, the average American will bear the brunt of higher borrowing costs. James Cassel, chairman and co-founder of the investment banking firm Cassel Salpeter in Miami had said that if aggressive rate hike happens, losers might include “construction-related businesses, like homebuilders.”

5 Winners

We have, thus, selected five solid stocks from the aforesaid sectors that are poised to gain from decelerated hikes in the near term. These stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).

Chesapeake Utilities Corporation (CPK - Free Report) is a diversified energy company that engages in regulated and unregulated energy businesses. The company has a Zacks Rank #2. In the last 60 days, two earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings has moved 1.2% up in the same time frame. The stock’s expected growth rate for the current year is 20.4% versus the Utility - Gas Distribution industry’s projected rally of 6.3%.

Ameren Corporation (AEE - Free Report) operates as a public utility holding company in the United States. It operates through four segments: Ameren Missouri, Ameren Illinois Electric Distribution, Ameren Illinois Natural Gas, and Ameren Transmission. The company has a Zacks Rank #2. In the last 60 days, three earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings has risen 0.3% in the same period. The stock’s expected growth rate for the current year is 7.4% versus the Utility - Electric Power industry’s estimated rally of 6.9%.

MYR Group Inc. (MYRG - Free Report) provides electrical construction services in the United States. It operates through two segments, Transmission and Distribution, and Commercial and Industrial. The company has a Zacks Rank #1. In the last 60 days, four earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings has moved almost 8% up in the same time frame. The stock’s expected growth rate for the current year is 150.6% versus the Electric Construction industry’s projected rally of 2.9%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Installed Building Products, Inc. (IBP - Free Report) engages in the installation of insulation, waterproofing, fire-stopping, fireproofing, garage doors, rain gutters, shower doors, closet shelving and mirrors, and other products in the continental United States. The company has a Zacks Rank #1. In the last 60 days, three earnings estimates moved up, while one moved down for the current year. The Zacks Consensus Estimate for earnings has climbed 3.9% in the same time frame. The stock’s expected growth rate for the current year is 41.9% versus the Building Products - Miscellaneous industry’s projected rally of 29%.

Toll Brothers, Inc. (TOL - Free Report) designs, builds, markets, and arranges finance for detached and attached homes in luxury residential communities in the United States. The company has a Zacks Rank #1. In the last 60 days, two earnings estimates moved up, while none moved down for the current year. The Zacks Consensus Estimate for earnings has moved 2.8% up during the period. The stock’s expected growth rate for the current year is 40.4% versus the Building Products - Home Builders industry’s estimated rally of 31.1%.

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