Back during the Jackson Hole Economic Symposium in August, Powell hinted
rather clearly that a rate cut was coming in the next Fed meeting. What the
effect of it will be on the markets remains to be seen. However, what we can
do is prepare ourselves. When the Fed starts easing further, the best
sectors to look at are usually financials (banks), REITs, and utilities.
These sectors are the most rate-sensitive, so we can dig a bit deeper to see
what we're working with.
When it comes to banks, the regionals are where the big money can be made
during these times, with a caveat, however. At first, regional banks might
struggle a bit. Net interest margins will compress, but they'll see an
influx of new loans soon after to compensate. That's why REITs also improve,
because those new loans could be used for housing. Finally, we frequently
see utilities benefit too; the companies in these sectors are usually very
debt-heavy. Think about the size of infrastructure, power plants, water
systems, electricity grids, gas distribution, etc. These need heavy upfront
investments, frequently financed with debt.
Take a look at the chart below. I will try to explain it a little bit more.
I have added the 30-day Fed Funds future with the inverted graph of the US
interest rate (Fed Funds). We can see that the market is pricing in a rate
cut in September. Based on what the comments will be from the Fed, further
rate cuts might be on the horizon, and the market will be pricing it in.
That's when we might see regional banks, housing, and utilities pick up the
pace and outperform.
So, it's something to keep in mind. If you're looking at stocks, a few extra
glances towards these sectors might be worth it. However, I do want to clear
it up that this rate cut isn't one borne out of panic due to recession risk.
That basically means we might see widespread improvement in all stocks,
especially cyclicals if they're debt heavy and demand picks up due to the
rate cuts. That goes for oil and materials, but also for technology and
small caps, they will start to improve too.
See the small-caps chart below that looks primed for a break above 2.45k
(Russell 2000). It's awaiting the crucial moment of the first rate cut in a
while.
So, what do you think? Which sectors will start picking up pace once that
first rate cut comes in?
Let me know!