Next week, the Fed is expected to announce its latest rate increase decision. Nearly all analysts had predicted a rate increase of at least 25 basis points up to last week. Some experts even suggested a 50-basis point increase.
Many are starting to wonder if the Fed will raise rates again after a few bank closings and some promising data from the most recent inflation report. Many are asking whether the Fed will raise rates at all. They fear that the economy might be ruined, echoing comments made by a Goldman Sachs economist.
It is important to be clear that the Fed is not yet in a position to bring inflation down below 2%. They are making progress. It’s possible that the Fed will reduce the fund rate by the end of the year if inflation continues to fall, particularly with all the pressures on banks.
Market sectors will be affected differently by lower interest rates. These three sectors are likely to be good candidates for “comeback” stocks if rates drop.
1. Consumer discretionary
2022 performance: -31.35%.
From year to year: 21.01%
Year to date: 8.50%.
Noteworthy companies: Nike. Tesla. HTML3_
Consumer discretionary, which sells things we don’t need but want, has performed well in low-rate economic environments.
Consumer discretionary, for example, was the highest performing S&P 500 performer between 2008 and 2015. It was there when the fund rate was between 0.0% and 0.2%. This was except 2011 and 2014. It was also the best performer in 2020.
This is partly due to the fact that consumers can borrow money at very low interest rates to finance purchases they don’t have cash for. Low rates also help consumer discretionary businesses have stronger balance sheets. According to Fidelity’s sector overviews, this sector is the most heavily indebted. It has a collective debt–to-equity ratio of 739.11 (a measure of the sector’s assets and its debts). It is therefore more profitable when borrowing costs are low.
Companies that are able to cross the line between selling discretionary products and essentials (consumer staples) will do better. This includes big-box retailers such as Costco, Walmart, and Target. This could also include internet providers like Comcast or Charter, who make their living from entertainment services.
2. Information technology
2022 performance: -24.12.
From year to year: 7.97%.
Year to date: 12.11%.
Noteworthy companies: Microsoft. Alphabet. Meta.
High interest rates can make the tech sector very sensitive. It’s actually because mid-cap tech firms had become so cash-strapped by the Fed’s incremental increases that Silicon Valley Bank’s fatal bank run didn’t happen at all.
This sector is second in debt with a 382.07 ratio. Low interest rates could help tech companies reduce operating costs and potentially increase profitability. It would also make it easier to borrow cash for product development and research.
However, tech companies are not always in trouble due to high interest rates. The least affected are companies with low debt to equity ratios. These companies include Alphabet and Microsoft, NVIDIA, and Apple. It also includes smaller companies such as Monolithic Power Systems which has a zero debt-to-equity.
However, startups and mid-cap tech companies will find it difficult to innovate in high-rate environments. This is particularly true for tech companies that have negative debt-to equity ratios like Etsy (-4.37) or Carvana (-17.02). These companies are more indebted than their assets and would do better with lower borrowing costs.
Carvana is an excellent example of how interest rates affect tech companies. Carvana’s stock reached a record $370 per share during the ultra low-rate environment in 2021. Now, Carvana’s stock sells for $7 per share.
2022 performance: 1.22%.
From year to year: @5.63%
Year to date: -5.45%.
Noteworthy companies: NextEra Energy and Duke Energy, American Water Works, Constellation Energy.
Utility stocks perform well in low-rate environments but not in the way you might expect.
Lower borrowing rates are a benefit to the sector, especially when new plants or infrastructure is being built. Utility stocks are more attractive than bonds because they offer higher dividend yields.
Because they attract conservative investors, bonds and utility stocks are in competition. These investors are looking for a stable investment with a high yield, regardless of whether it is a dividend or a bond yield.
Bonds became more appealing during periods of high interest rates. The yields are high and the investment is stable. Utility companies also have higher borrowing costs for outstanding debts, which could reduce dividends.
Conservative investors tend to gravitate towards utility stocks when interest rates are low. Bond yields are also lower when interest rates are low. Utility stocks start to pay more dividends, which makes capital gains attractive.
Since the Fed began raising rates, the sector has not performed badly. The sector’s push to renewables could lead to lower interest rates. This could transform a mundane stock like utilities into a promising growth area.
All 2023 numbers accurate as of March 15, 2015, close of market.
At the time of publication, the author was a shareholder in Tesla stock.