As the Federal Reserve prepares for its next meeting, expectations are building around a potential rate cut in September, despite no immediate changes anticipated in the upcoming meeting. The market is nearly certain that a reduction in interest rates will occur by September, setting the stage for a broader easing cycle that could extend into 2024 and beyond. This anticipation has fueled a significant rally in the stock market, driving major indexes closer to record highs.
The prevailing optimism stems from several key economic indicators. The current unemployment rate stands at a relatively low 4.1%, and the Federal Reserve’s projections suggest it will only inch up slightly in 2025. This relatively stable employment landscape provides the Fed with some leeway to lower rates without fearing immediate negative repercussions on the job market. The goal is to orchestrate a “soft landing” for the economy—slowing down inflation and addressing potential speculative excesses without precipitating a severe economic downturn or widespread job losses.
Historically, stocks have shown a tendency to rally into the first rate cut, then consolidate in the months following, and resume upward momentum if a recession does not ensue. Anastasia Amoroso, chief investment strategist at iCapital, notes that defensive sectors, such as consumer staples, healthcare, and utilities, often perform well during these periods of monetary easing. This trend reflects a broader pattern where investors seek stability in more resilient sectors when economic conditions are uncertain.
In the realm of real estate, lower interest rates are expected to enhance the appeal of real estate investment trusts (REITs). Jason Yablon, head of listed real estate at Cohen & Steers, highlights that REITs with exposure to data centers, senior living facilities, single-family rentals, and cellphone towers are particularly attractive. These sectors are expected to offer substantial dividend yields, making them more appealing compared to bonds, especially as rates decline.
Small-cap stocks are also positioned to benefit from the anticipated rate cuts. Sandy Villere, portfolio manager at Villere & Co., observes that small-cap stocks have recently rebounded by 10% since late June but still lag behind the broader market’s performance for the year. Lower interest rates are seen as a tailwind for these stocks, which typically gain traction when borrowing costs decrease. Villere has invested in smaller companies like First Interstate Bancsystem and Option Care Health and recommends considering defensive, larger companies such as Republic Services and Lamb Weston, which may continue to perform well even in a slowing economy.
Tech stocks are another area of interest, as a rate cut could drive cash from money-market accounts into equities, including technology sectors. Ivana Delevska, founder and chief investment officer at Spear Invest, believes that software stocks, which have not rallied as dramatically as semiconductor manufacturers, could benefit from this influx of capital. She points to cybersecurity firms like Zscaler, Cloudflare, Datadog, SentinelOne, and CrowdStrike as particularly promising investments.
Vance Howard, CEO of Howard Capital Management, also sees potential in a variety of stocks across sectors, including healthcare giants such as Eli Lilly, Regeneron, and Merck, as well as software leader Salesforce. Howard suggests that rate-sensitive small caps, including regional banks and real estate stocks, could offer attractive investment opportunities as rates decline.
Despite the generally optimistic outlook, it’s important to recognize that stock market reactions to rate cuts can be complex. Often, the anticipation of easing may already be reflected in stock prices, or rate cuts might follow significant economic challenges—such as those seen during the dot-com bubble burst in the early 2000s, the 2007-2008 financial crisis, or the COVID-19 pandemic. In such cases, even substantial rate cuts might not immediately counteract the negative effects on corporate earnings and investor sentiment.
Nonetheless, with the Federal Reserve not currently in panic mode, there is potential for a broad-based rally once the rate cuts commence. This could signal the beginning of a “Great Rotation” in stock gains, where different sectors and types of stocks gain prominence, reflecting a more balanced and sustained market rally.