Place your bets: Fed Reserve rate cut could set the stage for these sectors to sparkle

Fed’s expected rate cuts boost small-cap stock rally
Lower interest rates to benefit real estate and tech sectors
Silver and luxury sectors also poised for gains

After a long wait, it looks like September will finally see the Federal Reserve kick off its interest rate cut programme.

The US central bank is expected to make the move for the first time in over four years this Wednesday (US time), hoping to guide the US economy to a soft landing.

With US inflation under control and the job market under pressure, many are betting on at least a 0.25% (25 basis points) cut, with some hoping for a larger 0.50% reduction.

As of right now, the futures markets tell us that traders have priced in a 60% probability of a 50 bp cut.

The Fed’s decision will be closely watched, especially when Fed Chair Jerome Powell speaks to the press on the 18th.

The market will dissect his every word along with what’s called the ‘dot plot,’ which is a glimpse into each policymaker’s rate expectations through to 2027, giving a rare look into their thoughts.

The stakes are obviously high.

Whether the Fed chooses a modest 0.25% cut or a bolder 0.50%, the effects will ripple through the global economy, affecting investment strategies and market sentiment.

What the market has already priced in

It’s been 14 months since the Fed last raised rates to 5.5%, making it the second longest stretch between rate changes since 1970 (the historical average is about 8 months).

Most of the world’s major central banks, except for Japan and Australia, have already started cutting rates months ago.

Ahead of this historic decision, traders have strategically executed trades that are aligned with their views.

For example, many have been selling the US dollar, which has continued to weaken over the past week as anticipation of a rate cut grows.

This decline has led to a rise in currencies like the Aussie dollar and Japanese Yen versus the USD.

In tandem with the dollar’s drop, Treasury yields have also fallen (bond prices higher), with the benchmark 10-year yield dropping over 20 basis points in the past few weeks.

And gold prices have soared to a record high of US$2,589.50 on Monday. Typically, bullion prices climb when the USD falls, as gold is priced in dollars.

How to take advantage of the start of rate cuts

The shift in monetary policy is opening up new opportunities for investors.

Historically speaking, after the Fed’s first rate cut, US stocks have typically returned around 11% above inflation over the next year.

According to Hani Abuagla at investment firm XTB MENA, there are some sectors that might benefit the most from interest rate cuts:

Real estate sector

The real estate sector stands to gain the most from interest rate cuts, with residential properties likely to benefit the most.

Buying a home is a big investment, so many people turn to banks for financing. That makes interest rates a key factor in the housing market.

Also, property values are influenced by the expected future cash flows from rent or the property’s future value.

These cash flows are discounted based on interest rates, so when rates go down, property values usually go up, which is reflected in market prices.

Lower interest rates also benefit property developers by making borrowing cheaper.

When rates drop, developers can finance their projects at lower costs, which helps improve their profit margins.

“If housing prices have continued to rise with high interest rates, it is normal that with lower rates they will rise even more,” said Abuagla.

“For all these reasons, we believe that companies that promote, build or manage a property portfolio will benefit greatly from the rate cuts.”

Unfortunately in Australia, the RBA hasn’t made any rate cuts yet. As recently as last week, the central bank maintained the cash rate at 4.35%.

The Tech and Biotech sectors

Two of the great friends of low interest rates are the technology and the biotech sectors.

The benefits are similar to what we see in real estate, where lower rates boost asset values by reducing discount rates.

But with tech, there’s an extra twist, says Abuagla.

When interest rates are low, investors look for higher returns than what fixed-income investments offer. That’s when tech stocks shine.

They’re risky due to their disruptive nature, but they promise big rewards. So, when rates drop, many investors dive into tech and biotech companies.

Also, with lower interest rates and reduced returns from fixed-income investments, investors are more open to funding long-term projects that might not pay off immediately but have potentially big future gains.

This will help tech firms that are currently unprofitable but are growing rapidly, says Abuagla.

For example, back in 2019, when the last rate-cutting cycle began, the tech sector saw a huge 50% gain, while the S&P 500 rose by 30%.

“This doesn’t mean that in the next quarters we will see a rebound of such magnitude, but it does create the breeding ground for it,” Abuagla said.

Silver

Silver? Yes, Abuagla believes that incorporating some alternative assets such as raw materials into investment portfolios can help reduce risk.

Demand for silver has really picked up over the past year, thanks in particular to the renewable energy and solar panel sectors.

With the global push towards renewable energy, silver is in high demand, and solar panel companies are expected to use about 20% of the world’s silver, up from just 5% in 2014.

Recently, we’ve seen a big bounce back in this sector, largely because of the anticipation of upcoming rate cuts.

According to Abuagla, a lot of silver mining companies have high levels of debt to finance their projects, so lower rates would boost these stocks.

“Also, the gold/silver ratio is currently trading at levels close to 90, which has historically reflected that silver could be undervalued, taking into account that its average for the last 10 years is 77,” said Abuagla.

“Investors often turn to precious metals to protect their investments in times of uncertainty.

“When traditional currencies face challenges and risks, assets such as gold and silver stand out as a reserve of safety.

“Silver is also the raw material that has shown the greatest decorrelation with the dollar, also trading in a positive trend with the rise of the world markets,” said Abuagla.

Luxury sector

There’s a common belief that the luxury sector handles economic downturns better than other sectors.

The idea is that luxury buyers are less affected by economic troubles, so demand for high-end goods remains steady.

But, this isn’t always the case. To really understand how well the luxury sector holds up, we need to look at specific segments within the fashion industry.

“In fact, we could argue that the luxury sector is one of the main beneficiaries of low interest rates,” said Abuagla.

Small caps sector

Last but not least, small cap stocks, in general, could benefit significantly from upcoming rate cuts.

Small caps tend to benefit when interest rates fall because these companies often have higher levels of debt compared to larger firms.

Lower rates reduce the cost of borrowing, which directly boosts their profitability and financial stability.

As expectations for rate cuts increase, investors are also drawn to small cap stocks, anticipating that these companies will have improved conditions.

This shift in sentiment has already driven a rally in small cap stocks recently.

This story does not constitute financial product advice. You should consider obtaining independent advice before making any financial decision.