Learn about the potential effects of interest rate changes on different market sectors, and discover which companies may perform well in low-rate environments. Find out about consumer discretionary, information technology, and utility stocks, and get insights into the latest trends and predictions from financial experts.
Questions Answered in this Article
- What is the current speculation regarding the Fed’s rate hike decision?
- There are growing speculations that this could be the last time the Fed raises rates due to recent bank closures and mildly optimistic inflation data.
- What could happen if the current trend of decreasing annual inflation rates continues?
- If the trend continues, the Fed may consider cutting the fund rate by the end of the year, particularly given the latest pressures on banks.
- What sectors should be considered when looking for stocks likely to perform well when interest rates decrease?
- Consumer discretionary, information technology, and utilities.
- Why has the consumer discretionary sector historically performed well in low-rate environments?
- Consumers can take advantage of low-interest rates to finance purchases they cannot afford outright, and low rates can benefit consumer discretionary companies by improving their balance sheets.
- Why do conservative investors flock to utility stocks when interest rates are low?
- The yields on bonds are lower, making the dividends on utility stocks more attractive, and the potential for capital gains is also appealing.
The Potential Impact of Lower Interest Rates on Consumer Discretionary, Information Technology, and Utilities Sectors
The upcoming week will see the Fed announcing its latest rate hike decision. Initially, most analysts anticipated a minimum 25 basis point increase, with some being more aggressive with a 50-point hike. However, with recent bank closures and mildly optimistic inflation data, there are growing speculations that this could be the last time the Fed raises rates. Some experts are questioning if there will be any rate hike due to concerns about potential negative economic impacts.
Even though the Fed is still quite far from reaching its goal of 2% inflation, progress is being made. If the current trend of decreasing annual inflation rates continues, the Fed may consider cutting the fund rate by the end of the year, particularly given the latest pressures on banks.
It’s important to note that lower interest rates will have varying effects on different market sectors. However, if you’re looking for stocks likely to perform well when rates eventually decrease, it’s worth considering companies in three industries.
Consumer Discretionary Sector: Historical Performance in Low-Rate Environments
The consumer discretionary sector, encompassing companies such as Nike, Disney, Netflix, Airbnb, and Tesla, has had a mixed performance in recent years. In 2022, the sector saw a decline of 31.35%, while the year-to-year performance was down by 21.01%. However, the year-to-date performance has been positive, with a gain of 8.50%.
Despite its volatility, this sector has historically performed well in low-rate environments, even during weak economic conditions. For instance, between 2008 and 2015, when the fund rate was between 0% and 0.25%, consumer discretionary was among the top three performers in the S&P 500 index, except in 2011 and 2014. It also performed well in 2020.
One reason for this is that consumers can take advantage of low-interest rates to finance purchases they cannot afford outright. Additionally, low rates can benefit consumer discretionary companies by improving their balance sheets. According to Fidelity’s overviews, this sector is the most indebted, with a collective debt-to-equity ratio of 739.11. Thus, low borrowing costs can translate to higher profits.
Companies that straddle the line between selling discretionary goods and necessities, such as big box retailers like Target, Walmart, and Costco, will likely perform exceptionally well in this environment. Internet providers like Comcast and Charter, which earn revenue from entertainment services, may also benefit.
Information Technology Sector: Vulnerability to Interest Rate Changes
The information technology sector, home to major players such as Microsoft, Apple, Alphabet, and Meta, has had a mixed performance in recent years. In 2022, the sector saw a decline of 24.12%, while the year-to-year performance was down by 7.97%. However, the year-to-date performance has been positive, with a gain of 12.11%.
Tech companies can be susceptible to interest rate changes, as illustrated by the bank run at Silicon Valley Bank caused by incremental hikes. With a collective debt-to-equity ratio of 382.07, the tech sector is among the most indebted. Generally, low-interest rates would help tech companies reduce operating costs and possibly achieve profitability faster and make borrowing cheaper and more accessible for research and product development.
However, not all tech companies are equally affected by high rates. Companies with low debt-to-equity ratios, such as Alphabet, Apple, Microsoft, and NVIDIA, are less vulnerable. This also includes less well-known companies like Monolithic Power Systems, which has a zero debt-to-equity ratio.
On the other hand, mid-cap and startup tech companies may struggle to innovate in a high-rate environment, especially those with negative debt-to-equity ratios, such as Etsy (-4.37) and Carvana (-17.02). These companies have more debt than their assets can cover and would benefit from cheaper borrowing costs.
Carvana provides a compelling example of how interest rates can impact tech companies. In 2021’s low-rate environment, Carvana’s stock price reached an all-time high of $370 per share. In 2023, however, the stock price has fallen to around $7 per share.
Utilities Sector: Increased Appeal to Conservative Investors in Low-Interest Environments
The utility sector is another area that tends to do well in low-interest rate environments, but for different reasons.
While lower borrowing costs certainly benefit the sector, especially when it comes to building new plants or updating infrastructure, the appeal of utilities as a stock investment increases as interest rates decrease. This is because their dividend yields become more attractive to conservative investors who want a stable investment with a relatively high yield.
Bonds and utility stocks often compete for these types of investors looking for stable investments with good yields. Bonds tend to be more attractive when interest rates are high due to their high results and stability. At the same time, utility companies may struggle with higher borrowing costs and potential dividend cuts.
However, conservative investors flock to utility stocks when interest rates are low. The yields on bonds are lower, making the dividends on utility stocks more attractive, and the potential for capital gains is also appealing.
Although the utility sector hasn’t performed poorly during the Fed’s rate hikes, shifting towards renewable energy could turn this typically unexciting category into an exciting growth opportunity, especially if interest rates remain low.
Summary
- The Fed is set to announce its latest rate hike decision, with speculation that it could be the last time the rates are raised.
- Lower interest rates will have varying effects on different market sectors, and it is worth considering companies in the consumer discretionary, information technology, and utilities sectors.
- Consumer discretionary companies historically perform well in low-rate environments, as consumers can take advantage of low-interest rates to finance purchases they cannot afford outright.
- Companies that straddle the line between selling discretionary goods and necessities, such as big box retailers and internet providers, may also benefit.
- Information technology companies can be susceptible to interest rate changes, but those with low debt-to-equity ratios, such as Alphabet, Apple, and Microsoft, are less vulnerable.
- Mid-cap and startup tech companies may struggle to innovate in a high-rate environment, especially those with negative debt-to-equity ratios.
- Utility companies benefit from lower borrowing costs when building new plants or updating infrastructure, and their dividend yields become more attractive to conservative investors when interest rates decrease.
- The appeal of utilities as a stock investment increases as interest rates decrease, and their potential for capital gains is also appealing.
- Shifting towards renewable energy could turn the typically unexciting utility sector into an exciting growth opportunity, especially if interest rates remain low.