The Best Stocks to Buy in a Falling-Rate Environment
Which stocks should you buy when interest rates peak and begin to fall?
Based on the market’s performance over the last week, you might be tempted to say “all of them.” After all, the S&P 500 hit an all-time high on Thursday after the Federal Reserve held rates steady and discussed cutting them later in the year.
But despite the market’s euphoric reaction, this shift to a falling-rate environment doesn’t mean everything is hunky-dory. And it certainly doesn’t mean you should throw caution to the wind with your buying decisions.
In fact, a falling-rate environment isn’t exactly a positive signal for the economy. The Fed is moving toward cutting rates ahead of an anticipated economic slowdown.
With that in mind, investors should be selective with the types of stocks they’re buying as interest rates peak and begin to turn downward. Let’s look at some of the best-performing equities in falling-rate environments...
Medical treatment is a basic survival necessity, like food and water. People will never voluntarily stop paying for it.
In other words, health care businesses enjoy what economists call inelastic demand — they’re more or less unaffected by changes in price or consumer income.
That makes health care stocks good investments at precarious times like market tops and bear markets (as I discussed in my recent article about health care stocks in late-stage bull markets).
And historical data suggests that health care stocks do particularly well in the months after interest rate cuts. A chart assembled by Barclays and published by CNBC shows that health care stocks outperform the market by an average of 7% in the nine months after a rate cut, regardless of whether the rate cut is motivated by a recession or a minor slowdown.
Sources: Barclays, CNBC
With their inelastic demand, high gross profit margins, and historical robustness, health care stocks are well prepared for whatever the Fed might throw at them next.
The utilities sector is one of the most bond-like areas of the stock market. Utilities firms use their steady cash flows to pay big dividends to investors; they currently sport an average yield of around 3%. They also tend to have lots of debt on their books.
With these things in mind, it should be no surprise that utilities stocks tend to do relatively well in falling-rate environments, even if interest rates are falling because the economy is in tatters.
Just look at the last period of falling rates — the period between June 2006 and December 2008, when the Fed cut rates from 5.25% to 0.25% as the Great Recession reared its ugly head.
While the S&P 500 lost almost a third of its value, the SPDR Utilities Select Sector ETF (NYSE: XLU) posted single-digit losses.
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Basic consumer staples stocks are also good buys in times of falling rates and economic uncertainty. Like health care stocks, consumer staples firms benefit from inelastic demand because their products are survival necessities.
But there’s another reason consumer staples companies are particularly good purchases in falling-rate environments: lots of people buy their gas, groceries, and other staples on interest-bearing credit cards.
In fact, according to a 2016 TSYS U.S. Consumer Payments study, credit cards are the preferred method of payment at department stores, gas stations, and supermarkets.
Sources: TSYS, CreditCards.com
Falling interest rates mean cheaper credit for consumers, and thus easier spending on consumer staples.
It’s no wonder the SPDR Consumer Staples Select Sector ETF (NYSE: XLP) barely lost any value during the last round of interest rate cuts.
For now, the market still seems euphoric about the Fed’s interest rate dovishness — and that’s probably a mistake.
However, as we’ve discussed today, some sectors do outperform when interest rates are in a downtrend, and now might be a good time to add to your holdings in those sectors.
Until next time,
Samuel Taube brings years of experience researching ETFs, cryptocurrencies, muni bonds, value stocks, and more to Wealth Daily. He has been writing for investment newsletters since 2013 and has penned articles accurately predicting financial market reactions to Brexit, the election of Donald Trump, and more. Samuel holds a degree in economics from the University of Maryland, and his investment approach focuses on finding undervalued assets at every point in the business cycle and then reaping big returns when they recover. To learn more about Samuel, click here.
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