Investopedia: 4 Ways to Play Equities if the Fed Cuts Rates

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Stocks have rebounded sharply in recent days as investors expect a new round of Federal Reserve rate cuts. The question is how to profit off it. Goldman Sachs Group Inc. says there may be four key ways that investors can outperform during the 12 months after the first rate cut if the Fed take steps to extend the length of the 10-year bull market. That includes two sector plays, which are health care and consumer staples stocks, and two thematic plays, which are momentum or low volatility stocks.


Investors anticipate the first rate cut will come before the end of 2019, followed by several more in 2020. No matter what investors buy, they will have the wind at their back. “The S&P 500 index has typically generated strong returns at the beginning of Fed cutting cycles,” Goldman says in its latest Weekly Kickstart report. Goldman studied S&P 500 Index returns during the 35 years following the start of 7 Fed rate cutting cycles, or the first interest rate cut during the trailing 12 months. The index rose by a median of 2% during the first three months, and by an impressive 14% during the 12-month period after the start of a Fed cutting cycle. 


4 Ways to Play the Next Round of Rate Cuts:


  • Health Care
  • Consumer Staples
  • Low Volatility
  • Momentum


Source: Goldman Sachs





What it Means for Investors

Investor anticipation of lower rates has been fueled by signs of a slowing economy, including weakness in manufacturing and jobs data last week, with futures markets now pricing in the 90% likelihood of a Fed rate cut before the year is out.


Goldman says that these two sectors and two themes may be the best way to profit in this environment, at least in the first year.


Sectors

The top performing sectors in Goldman’s analysis were health care and consumer staples. Health care has outpaced the S&P 500 by a huge margin, a median of 9 percentage points, over the 12 months following the start of a rate-cutting cycle. Consumer staples stocks have posted similar gains. By contrast, Goldman notes that the communication services sector posted strong returns three months after a rate cut but fared poorly over 12 months. And tech stocks were the worst performing sector, lagging by 13 percentage points over one year.



Momentum, Low Volatility Stocks

Goldman’s study also showed that its “long/short Momentum factor” returned a median of 9% during year following prior rate cuts, and 13% if one excludes the years 1998 and 2001, when cuts came as a surprise. The firm gave less detail about low volatility themes, but it noted that low volatility performed extremely well last month, rising 9% as a group. 

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Looking Ahead

The question of whether the Fed will or will not cut is still open. But it is worth noting that on 13 occasions since 1988, when futures markets expected a cut in the fed funds rate the day prior to a Federal Open Market Committee (FOMC) meeting, the Fed cut rates every time. Further, only twice over the past 30 years has the Fed not cut interest rates when futures markets have predicted a cut 30 days prior to a scheduled FOMC meeting. Goldman says the market expects rates to stay unchanged after the Fed’s meeting next week, but that a rate cut is expected in July.







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Source: investopedia.com

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