After the turmoil in the global equity markets earlier this month, a debate is raging among economists and Fed watchers over the perceived need for an emergency rate cut, which should prompt investors to consider how to position themselves in the best sectors for a period of falling interest rates.
Of note, the celebrated Wharton School professor, Jeremy Siegel, recently made headlines with his recommendation for the Fed to aggressively cut its benchmark interest rate from its current 5.3% to “at or below 4%.”
And though Siegel later backed off from this call, he told CNBC that he still wants policymakers to cut “quickly and aggressively.” Indeed, a growing number of analysts echoed this sentiment in calling for a “significant” 50-basis-point cut to the fed funds rate at next month’s Fed policy meeting (although most observers expect a more conservative 25-basis-point cut).
While the debate over the size of rate cuts rages on, it’s clear we’re entering what looks to be the early stages of a period of falling interest rates. The widely watched 10-year Treasury Yield Index (TNX) has recently fallen from a multi-year high of 4.6% to a one-year low of 3.8% as defensive-oriented investors have lately run to the perceived safety of government bonds.
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Mortgage rates also dropped to their lowest level in over a year last week, which housing market analysts attribute to the widely held expectation that the Fed will soon begin cutting rates.
On this score, the Financial Times noted that the recent stock market turmoil “prompted investors to dial up their expectations of interest rate cuts, with markets now pricing in four quarter-point reductions by the end of December, compared with two last month.”
With market rates already in decline, it’s time for investors to turn their attention to stock market sectors that are likely to outperform with falling interest rates. I’ve isolated three such rate-sensitive sectors that I think offer varying degrees of turnaround potential in the intermediate-to-longer-term outlook based on where they are in their current turnaround cycle. I’ve ranked them for you in descending order, so let’s look at them:
3 Sectors That Benefit Most from Falling Interest Rates
#3: The Utility Sector
Utility stocks, of course, offer excellent income potential and should benefit if the Fed embraces a dovish policy stance as expected. However, this sector is already well into a turnaround and has likely already discounted much of the market’s near-term interest rate expectations. That said, with the “electrification of everything” trend heating up and putting massive demand on power generation, utility stocks certainly offer longer-term investment potential.
#2: The Retail Sector
This sector is also rate-sensitive to a degree and is entering what I regard to be the middle stage of its industry-wide turnaround. Consumer staple stocks, a sub-set of retail sector stocks, look especially attractive and are also benefiting from safe-haven demand. Moreover, consumer staples companies often pay regular dividends, providing a source of income for investors and providing extra attraction in a weak broad market environment. To that end, the Consumer Staples Select Sector SPDR ETF (XLP) offers broad exposure to the overall sector.
#1: The Real Estate Sector
REITs look to be a prime field for finding early-stage turnaround candidates, an outlook that can only improve in a falling rate environment. That said, due to the enormous leverage and hyper-volatility of this sector, I don’t anticipate very many low-risk turnaround recommendations in this category going forward. Unless I see what amounts to a screaming buy opportunity, much of my focus in the coming weeks likely will be within the second-ranked category, viz. retail.
What makes retail stocks particularly attractive is that they’re entering the middle phase of a turnaround cycle. And while this obviously doesn’t offer the same value as an early-stage turnaround, in most cases, it’s actually where some of the best asymmetric opportunities are to be found (i.e. they offer a lower probability of failure and a higher probability of success). That’s because mid-stage turnarounds have already established a large measure of forward momentum, which can never be dismissed, making further gains easier to achieve in the intermediate term.
Plus, with consumer borrowing costs likely to fall, the overall retail sector should benefit since it helps consumers finance purchases through credit. All told, the outlook for retail sector stocks in the aggregate is favorable in view of what should be a sustained period of falling interest rates ahead.
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