The Federal Reserve kicked off rate cuts in September with what is expected to be an easing campaign that “recalibrates” interest rates toward more “normal” levels through 2025. While the Fed’s opening cut was larger than some anticipated, we viewed the 50-basis-point move as a potential insurance policy on economic stability rather than reason for panic.
Importantly, we see no red lights flashing “recession.” Yet we do expect equity market volatility to loom amid the upcoming election and as incoming economic data is interpreted and future Fed decisions crystallize.
Implications for equity investors
As we noted in our recent equity market outlook, rate cuts are generally good for equities ― whether a recession is in the mix or not. And while the investing playbook may not look exactly the same in every rate-cutting cycle, history can be informative.
We combine historical perspective with our current-day observations to offer these takeaways for equity investors as the Fed begins what is likely to be a months-long rate-cutting campaign:
Healthy outlook for healthcare stocks
Our analysis of data across six rate-cutting cycles since 1984 finds that the healthcare and consumer staples sectors have historically emerged as top performers in the one, two and three years following the first Fed rate cut, as shown in the chart below.
Healthcare has other pluses going for it: A record of relative outperformance across market regimes; secular tailwinds in an aging population that is likely to spend more on health-related needs; and growth potential powered by innovation (the GLP-1 diabetes and weight loss drugs being just one example). Our global Fundamental Equities platform generally remains overweight to the sector.
Bigger potential in large over small
Large-cap stocks historically have outpaced smaller counterparts in the 12 months after cutting begins, as illustrated below. While long-beleaguered small caps have gained some attention of late, we remain cautious. Small caps screen as expensive versus their larger brethren while also exhibiting lower quality ― double jeopardy, we believe, in a slowing economy.
Meanwhile, we find that the stocks of many large-cap companies with strong underlying fundamentals have been overlooked as the high-flying mega-caps (aka the “Magnificent 7”) skew the valuation of the S&P 500 Index. As of mid-September, the average valuation of the capitalization-weighted S&P 500 Index was 25% higher than the equal-weighted index, which proportions all 500 stocks equally.
Mid-cap stocks also warrant consideration. Mid-sized companies tend to have more floating-rate debt on their balance sheets than larger counterparts, putting them in a favorable position as rates fall.
New versus old ‘staples’
As noted above, consumer staples have a record of outperformance in the one to three years following an initial rate cut. We find the sector to be well priced after lagging in the 2023-2024 market rally, with attractive return prospects over a one-year horizon. Yet its future may not be as robust as in prior cycles. The catalysts for significant staples growth, such as the 1980s’ rising crop of dual-income families embracing the convenience of packaged foods, are mostly played out.
Meanwhile, the technology sector, a relative underperformer in prior cutting regimes, demonstrates more “staples-like” characteristics in 2024 and beyond as the world is increasingly digitized. Tech also has a powerful catalyst in the artificial intelligence (AI) boom that is in very early innings with the potential to transform businesses across the global economy for many years to come.
Real estate-related beneficiaries
Real estate becomes more interesting with a rate-cutting cycle underway. Homebuilders, for one, benefit from the drop in 30-year mortgage rates, which should boost new home sales ― even as earnings for these companies have already been strong amid a dearth of existing homes for sale. As mortgages become more affordable and housing turnover increases, companies such as title insurers and mortgage writers could be beneficiaries as well.
For consumers, a matter of discretion
We are seeing signs of stress, particularly among the lower-income consumer, and more prudence being applied to discretionary purchases across income cohorts. But falling rates have us incrementally more bullish, particularly as the cycle advances. Lower rates allow consumers to finance big-ticket items they may have been delaying, such as autos. As consumers are applying extra discretion, so are we. Stock selection is especially important in the current environment, as not all consumer companies will benefit equally.
On watch for a dividend revival
As the Fed cuts rates, the days of 5% yields on cash are numbered. The retired and near-retired populations in the U.S. are growing, setting the stage for an increasing need for income-producing assets. This makes dividend-paying equities a more compelling consideration after years of 5% risk-free rates. With the average dividend yield on the major large-cap indexes still sub-2%, actively managed dividend strategies that can offer yields rivaling bonds and cash become a more attractive consideration.
Bottom line
Rate cuts historically have been positive for stocks, and we see no reason to expect this time would be different. However, the opportunities on offer are subject to change in any given cycle based on underlying market, sector and industry dynamics ― and companies’ individual ability to navigate them.
We believe this is where active management can be additive, particularly in periods of transition and in the broader context of what we see as a new era for equity investing in which alpha, or above-market returns, may be a more critical portfolio input.
Investing involves risk, including possible loss of principal. Stock values fluctuate in price so the value of your investment can go down depending on market conditions.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 2024 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results.
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