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Chances of Fed Rate Cut in October Rise: Sector ETFs to Buy

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Cheap money flows have been the biggest catalyst behind the stock market rally in recent months. The Fed has slashed interest rates two times this year — in July and in September — by 25 bps each to sustain a decade-long economic expansion. The trend is likely to continue this month, given the barrage of downbeat data that points to a deeper economic problem.

The Institute for Supply Management’s purchasing managers index for the manufacturing sector dropped to 47.8 in September, representing the lowest level in more than a decade. A private-sector employment report from Automatic Data Processing showed that a modest 135,000 jobs were created in September. Average monthly job growth fell to 145,000 over the past three months from 214,000 in the year-ago quarter. Meanwhile, the Institute for Supply Management’s non-manufacturing activity index also fell to 52.6 in September, the lowest since August 2016 (read: ETF Market Outlook for Q4 2019).

Further, global slowdown concerns arising from Sino-American trade war, lingering worries about Britain’s exit from the European Union as well as the political drama around Trump’s impeachment inquiry continued to unnerve investors.

All these uncertainties have raised the prospect of a third rate hike this year. Per CME Group's Fed Watch tool, rate cut bets for October surged to 90% from 40%.

Sectors to Ride On

In a lower-rate environment, high-dividend yieldìng sectors such as utilities and real estate will be the biggest beneficiaries, given their sensitivity to interest rates. This is especially true as these offer higher returns due to their outsized yields. Additionally, securities in capital-intensive sectors like telecom would also benefit from lower rates. Further, lower interest rates will keep borrowing cost down, thereby resulting in higher consumer spending and rise in economic activities. This will, in turn, increase profitability across various segments. Businesses will also face lower loan rates over time (read: Sector ETFs, Stocks Set to Explode After Another Rate Cut).

Meanwhile, gold mining stocks will also get a boost, given that these are leveraged plays on the underlying metal. The dual tailwinds of easing policies and flight to safety amid geopolitical tensions and global growth worries will raise the appeal for gold, pushing prices higher.

Given this, we have highlighted popular ETFs from these sectors set to benefit further on rate cuts.

Real Estate: Vanguard Real Estate ETF VNQ

This fund targets the real estate segment of the broader U.S. market. It follows the MSCI US Investable Market Real Estate 25/50 Index and holds 185 stocks in its basket with none accounting for more than 7.2% share. Specialized REITs takes the largest share at 34.2% while residential REITs and retail REITs round off the top three with double-digit exposure each. Expense ratio comes in at 0.12%. VNQ is the most popular and liquid ETFs with AUM of $36.2 billion and average daily volume of around 4.8 million shares a day. It has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Here's Why So Many Real Estate ETFs Near 52-Week High).

Utilities: Utilities Select Sector SPDR (XLU - Free Report)

With AUM of $11.2 billion, this fund provides exposure to a small basket of 28 securities by tracking the Utilities Select Sector Index. It is heavily concentrated on the top firm with 12.8% share while other firms hold no more than 8% of the assets. Electric utilities takes the top spot in terms of sectors at 61.1%, closely followed by multi utilities (32.5%). The product charges 13 bps in annual fees and sees heavy volume of around 17.1 million shares on average. It has a Zacks ETF Rank #3 with a Medium risk outlook (read: 4 Market-Beating Sector ETFs of the Third Quarter).

Homebuilders: iShares U.S. Home Construction ETF ITB

This fund provides exposure to U.S. companies that manufacture residential homes by tracking the Dow Jones U.S. Select Home Construction Index. With AUM of $1.3 billion, it holds a basket of 45 stocks with double-digit concentration on the top two firms. The product charges 42 bps in annual fees and trades in heavy volume of around 2.1 million shares a day on average. It has a Zacks ETF Rank #3 with a Medium risk outlook.

Gold Mining: VanEck Vectors Gold Miners ETF GDX

This is the most-popular and actively traded gold miner ETF with AUM of $11.5 billion and average daily volume of around 54.4 million shares. The fund follows the NYSE Arca Gold Miners Index, holding 45 stocks in its basket. Canadian firms account for half of the portfolio, while the United States (17.1%) and Australia (15.7%) round off the top three. The fund charges 52 bps in annual fees (read: Guide to 10 Most-Heavily Traded ETFs).

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