The Fed is widely expected to cut benchmark borrowing rates, at least modestly, for the first time in more than a decade on Jul 31. And that’s good news for Wall Street. After all, markets tend to gain after rate cuts.
Rate cuts are, thus, a seasonal buying opportunity, with some sectors traditionally performing well. Thus, investing in such sectors seems prudent at the moment.
Fed Rate Cut Likely
According to the CME Group data, market pundits are now pricing in a roughly 78% chance of a quarter of a percentage point rate cut to a range of 2%-2.25% from 2.25%-2.50% this month. And the chances of half a point cut are around 22%. Basically, a rate cut of some magnitude is inevitable.
In fact, Q2 GDP has reinforced expectations of a rate cut. Since trade war has impacted business and trade, Fed’s resolve to cut rates has strengthened. Sluggish inflation further increases the chances of a rate cut. Fed Chair Jerome Powell has dropped enough hints regarding a potential rate cut this month, primarily because of concerns about global economic growth weighing on corporate earnings.
To top it, President Trump is building pressure on the Fed to cut interest rates to bolster the U.S. economy. In fact, Trump recently tweeted that he wants to appoint Judy Shelton and Christopher Waller to the Federal Reserve board. Both of them are known for supporting lower interest rates. They believe that lower interest rates and a loose monetary policy will help the economy expand in the near term.
Markets Tend to Rally When the Fed Cuts Rate
A rate cut, surely, is a boon for the stock market. After all, the stock market has traditionally rallied following rate cuts as it translates into lower borrowing costs for both business houses and individuals, which in turn tends to push stocks higher.
Since 1990, on average, the S&P 500 has gained 0.16% on the day of a 25-basis-point cut. And the broader benchmark advanced 0.34% one month later.
A quarter of a percentage point cut is, in fact, a Goldilocks numbers. This is because the S&P 500 went on further to notch an average return of 3.67% three months later and 5.64% in six months. Whereas, cuts of a 50-basis points or greater has mostly resulted in losses in the upcoming quarter and half year period. Have a look at the table –
But why do stocks tend to decline when there are sizeable cuts? This is because sizeable cuts may indicate that the economy is not in good shape. But, the upcoming rate cut is better known as an insurance cut, which is just aimed to mitigate only the long-standing trade issue between the United States and China. Nonetheless, the possibility of a modest rate cut positions the stock market for gains.
Rate-Sensitive Stocks to Gain
We should keep in mind that even though the stock market tends to gain, there are several sectors including utilities and real estate that do remarkably well in case of a rate cut. This is because utilities are capital-intensive businesses and the funds generated from internal sources are not always sufficient to meet the requirements. Consequently, these companies have high levels of debt. Thus, low interest rates will help pay off debts and book profits.
However, 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, higher interest rates will increase borrowing costs for projects, which will significantly affect companies, predominantly involved in the construction business.
Gold Prices Rise
Gold mining stocks also have a fair chance to gain. Thanks to the dovish expectations, gold prices are expected to rise. This is because lower interest rates tend to make bonds and other fixed-income investments less attractive.
Money will flow out of bonds as they can’t provide higher yields, and in turn may flow into gold. It’s worth pointing out though that the yellow metal offers no yield at all.
Top 5 Choices
We have, thus, selected five solid stocks from the aforesaid sectors that are poised to gain from an expected rate cut. These stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).
American Water Works Company, Inc. (AWK - Free Report) provides water and wastewater services. The stock currently has a Zacks Rank #2. The Zacks Consensus Estimate for its current-year earnings has advanced 0.6% in the past 90 days. The company’s expected earnings growth rate for the current year is 9.1% compared with the Utility - Water Supply industry’s estimated rise of 1%.
Unitil Corporation (UTL - Free Report) , a public utility holding company, engages in the distribution of electricity and natural gas in the United States. The stock currently has a Zacks Rank #1. The Zacks Consensus Estimate for its current-year earnings has increased 0.9% in the past 60 days. The company’s expected earnings growth rate for the current year is 4% compared with the Utility - Electric Power industry’s estimated rise of 0.8%. You can see the complete list of today’s Zacks #1 Rank stocks here.
KB Home (KBH - Free Report) operates as a homebuilding company in the United States. The stock currently has a Zacks Rank #2. The Zacks Consensus Estimate for its current-year earnings has moved up 1.9% in the past 60 days. The company’s expected earnings growth rate for the current year is 56.7%, compared with the Building Products - Home Builders industry’s expected decline of 9.3%.
AngloGold Ashanti Limited (AU - Free Report) operates as a gold mining company. The company has a Zacks Rank #2. The Zacks Consensus Estimate for its current-year earnings has moved up 10.9% over the past 60 days. The company’s expected earnings growth rate for the current year is 111.3% compared with the Mining - Gold industry’s estimated rally of 10.8%.
Kinross Gold Corporation (KGC - Free Report) engages in the acquisition, exploration and development of gold properties in the United States. The stock currently has a Zacks Rank #1. The Zacks Consensus Estimate for its current-year earnings has climbed 66.7% in the past 60 days. The company’s expected earnings growth rate for the current year is 100% compared with the Mining - Gold industry’s projected rally of 10.8%.
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