3 Sectors That Would Benefit From Lower Interest Rates
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Next week, the Fed will announce its latest rate hike decision. Until last week, nearly every analyst was expecting a rate hike of at least 25 basis points, with some aggressive estimates coming in at 50.
But toss in a bank closure (or two) and mildly promising data from the latest inflation report, and many are beginning to wonder if this could be the last time the Fed raises rates. Some — echoing widely reported comments from a Goldman Sachs economist — are even asking if the Fed will raise the rate at all, citing worries over breaking something in the economy.
To be clear, the Fed is still far from getting inflation into a safe zone of 2%. But they’re making progress. And if the annual inflation rate continues to drop, it’s not hard to imagine the Fed cutting the fund rate by year’s end, especially with the latest pressures on banks.
Lower interest rates will affect market sectors differently. But if you’re looking for good “comeback” stocks in the near future, companies in these three sectors will likely do well when rates are finally lowered.
1. Consumer discretionary
2022 performance: -31.35%.
Year to year: -21.01%.
Year to date: 8.50%.
Notable companies: Nike, Disney, Netflix, Airbnb, Tesla.
The consumer discretionary sector — which sells stuff we want but don’t need, like cars and athletic apparel — has historically performed well in low-rate environments, even while the economy is weak.
For example, between 2008 and 2015, when the fund rate was between 0% and 0.25%, consumer discretionary was in the top three S&P 500 performers every year except 2011 and 2014. It was also the second-best performer in 2020.
This is partly because consumers can borrow money at low interest rates to fund purchases they don’t have cash for. It’s also because low rates help consumer discretionary companies have stronger balance sheets. This sector is the most indebted, as measured by a collective debt-to-equity ratio (a measure of its assets and debts) of 739.11, according to Fidelity’s sector overviews. As such, it sees much higher profits when borrowing costs are low.
Companies that will perform even better are those that straddle the line between selling discretionary goods and those goods we cannot live without (consumer staples). This would include big box retailers like Target, Walmart and Costco. It might also include internet providers such as Comcast and Charter, which earn revenues off of entertainment services.
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2. Information technology
2022 performance: -24.12.
Year to year: -7.97%.
Year to date: 12.11%.
Notable companies: Microsoft, Apple, Alphabet, Meta.
The tech sector can be very sensitive to high interest rates. In fact, it’s because mid-cap tech companies had become so cash-strapped under the Fed’s incremental hikes that the fatal bank run at Silicon Valley Bank happened at all.
The sector has a collective debt-to-equity ratio of 382.07, making it the second highest indebted. In general, low interest rates would help tech companies decrease operating costs and possibly achieve profitability faster. At the same time, it would make borrowing cash for research and product development cheaper and more accessible.
That said, not all tech companies flounder under high rates. Companies with low debt-to-equity ratios are the least affected. These include big names like Alphabet, Apple, Microsoft and NVIDIA. But it also includes lesser-known companies like Monolithic Power Systems, which has a debt-to-equity ratio of zero.
On the flip side, mid-cap and startup tech companies will have a hard time innovating in a high-rate environment. This is especially true for tech companies with negative debt-to-equity ratios, like Etsy (-4.37) and Carvana (-17.02). These companies have more debt than its assets can cover and would perform better with cheaper borrowing costs.
Carvana is a good example of how interest rates can affect tech companies. During the uber low-rate environment of 2021, Carvana’s stock price hit an all-time high of $370 per share. Fast forward to 2023 and Carvana’s stock is now selling for about $7 a pop.
2022 performance: 1.22%.
Year to year: -5.63%.
Year to date: -5.45%.
Notable companies: NextEra Energy, Duke Energy, American Water Works, Constellation Energy.
Utility stocks also perform strongly in low-rate environments, but not in the ways you might think.
Sure, the sector benefits from lower borrowing rates, especially when companies are building new plants or updating infrastructure. But as a stock investment, utilities become more attractive when rates are low because their dividend yields begin to look more favorable compared to bonds.
Bonds and utility stocks compete with each other, because they both attract conservative investors. These investors want a stable investment that has a fairly high yield, whether it's a bond yield or a stock dividend.
During periods of high rates, bonds became more attractive. The yields are high, and the investment is stable. At the same time, utility companies incur more borrowing costs on outstanding debts and could cut dividends in the short term.
Conversely, when rates are low, conservative investors gravitate to utility stocks. Low interest rates make bond yields also low. The dividends on utility stocks begin to look more favorable, and the opportunity for capital gains is also attractive.
The sector hasn’t performed horribly since the Fed started hiking rates. But lower interest rates in the future might also coincide with the sector's push for renewables. That could make a boring stock category like utilities into an exciting growth opportunity.
All 2023 figures accurate as of close of market on March 15.
The author owned Tesla and Airbnb stock at the time of publication.