On March 15, the Federal Open Market Committee (FOMC) of the Federal Reserve lowered the target range for federal funds to zero from one-quarter of a percent. The move was not well-received by investors looking for stocks to buy.
Major indices fell by at least 12% the following day. A rate cut often is seen as bullish by equity investors, but in this case the Fed’s move backfired.
That said, U.S. stocks have bounced back over the past few sessions. The S&P 500 (.SPX), for instance, clawed back about three-quarters of its March 16 losses. With the Fed’s move now backed by a multi-trillion dollar stimulus package, investors have increasing confidence that the economy can get through the coronavirus crisis.
In other words, investors are starting to look forward again. Those investors should consider the potential impact of the Federal Reserve rate cut. In theory, lower rates should help all stocks. For these seven names, however, near-zero rates could be particularly beneficial.
A CNBC analysis last year found that Caterpillar (CAT) had posted the second-best performance among Dow Jones Industrial Average (.DJI) components on the day of a Federal Reserve rate cut. CAT stock on average rallied 1.9%.
That average took a hit this year, as CAT stock fell over 6% the day after the most recent cut. But that decline was better than the market as a whole and Caterpillar stock has rallied nicely since.
There could be more upside ahead. It might seem dangerous to own such a cyclical stock ahead of what seems likely to be an economic recession. At least in theory, CAT’s multiple should expand if earnings stumble.
The rate cut may help as well. Lower interest rates can boost construction activity which could in turn drive demand for Caterpillar equipment. Higher commodity prices are another potential effect of the rate cut, and those prices would boost sales in the mining business.
That’s why CAT stock historically has done well when the Fed cuts rates. And if the global economy can recover from this crisis in short order, CAT should do well after this cut, too.
Lennar and D.R. Horton
The case for Lennar (LEN) and D.R. Horton (DHI), the nation’s two largest homebuilders, is simple. A lower Federal Reserve rate means lower mortgage rates — and thus lower monthly payments. As a result, near-zero interest rates should help home prices and demand.
The case against LEN and DHI is almost as simple: like Caterpillar, both companies are exceptionally cyclical. Lower mortgage rates in a recession aren’t enough to attract customers who don’t have a job or who see their hours or wages cut.
Indeed, both stocks have plunged during the recent sell-off. And over the long haul, neither stock has been all that impressive. Even with a bounce, LEN now trades where it did seven years ago. DHI has done better: its 32% return over the past five years topped the S&P 500 recently (today DHI is at 30%). But in what was mostly an upcycle, that performance is solid, yet not spectacular.
Still, on the dip both stocks look attractive. Demand for homes isn’t going to suddenly end. Both companies have solid balance sheets to ride out a downturn. Mortgage rates at 3.5% may make buying preferable to renting — and that could provide a multi-year tailwind for both homebuilders.
Utilities like AES Corporation (AES) have surprisingly plunged during this sell-off. The Utilities Select SPDR Fund (XLU), a sector exchange-traded fund, has declined 23% from February highs.
AES stock has done even worse: it’s still 37% below its peak. That’s the biggest decline among major utilities — which makes AES an intriguing choice to buy what looks like a somewhat unjustified sell-off.
After all, utilities should be mostly defensive businesses and stocks to buy. There will be some short-term impacts to profits from this pandemic as states roll back price increases (as recently occurred in New York State) and require forbearance of unpaid bills. But from a long-term perspective, earnings shouldn’t move all that much.
Meanwhile, low interest rates usually make the sector attractive in a zero-rate environment. The Federal Reserve rate cut has knock-on effects for instruments like savings accounts (which will yield almost nothing) and Treasury bonds.
AES yields over 4% — a payout which should look quite generous going forward. That alone may be enough for buyers to step in.
Johnson & Johnson
The rate cut should help Johnson & Johnson (JNJ) stock in two ways.
First, as a multinational business, the lower interest rates in theory should weaken the dollar. That hasn’t quite happened yet, as a “flight to safety” in global markets led investors to bid up the U.S. dollar against alternatives like the euro and the yen. The U.S. Dollar Index, often referred to as the DXY, actually rallied after the cut before a recent retreat.
Still, over time, lower interest rates (and lower Treasury yields) might stem some of the flows into U.S. currency. And a weaker dollar is beneficial for J&J, which generated nearly half of its 2019 sales overseas.
The second boost could come J&J’s own dividend. With legal liabilities (hopefully) in the rear-view mirror, JNJ should be one of the lower-risk stocks in the market. A yield right at 3% could draw investors looking for income beyond the fixed-income market.
JNJ stock has bounced since plunging to a three-year low just a few sessions back. On its own, I believe the stock has room to run. A zero-interest rate environment could provide some help along the way.
Procter & Gamble
The best Dow stock on the day of a rate cut historically has been consumer products giant Procter & Gamble (PG), which on average has gained over 2%.
As with CAT, that trend didn’t hold this time around: PG stock lost almost 5% the day after the Federal Reserve move. But as with CAT, that decline was far less than that since elsewhere in the index or the market at large.
Going forward, P&G needs at least a stable dollar, though a weak one would be preferable. In fiscal 2019 (ending June), P&G generated nearly 58% of its sales outside the U.S.
The strong dollar of the last few years has provided an enormous hit to earnings. In 2017, the company estimated the impact to earnings at over $1 billion annually. The Federal Reserve rate cut won’t necessarily solve that problem, but at least it won’t make it worse.
Gold should rally off a rate cut since lower rates increase the potential for inflation. So, too, does the multi-trillion-dollar stimulus package, which will only add to the rising national debt.
Indeed, gold has done so, touching a seven-year high earlier this month. Royal Gold (RGLD) should be a beneficiary.
Royal Gold is what’s known as a gold streamer: it funds miners in return for a cut of future production. That model moves investors away from direct ownership of miners — unquestionably a good thing.
As I noted in a detailed study of Barrick Gold (GOLD), those miners have done a horrific job of executing on their directive to provide leverage to the gold price. Put another way, miners have proven excellent at enriching their executives, and mostly poor at doing the same for shareholders.
There are miners out there worth a look, with Kinross Gold (KGC) one example. But investors betting on gold would do better with direct ownership or with a streamer like Royal Gold.
RGLD in fact has outperformed the gold price over multi-year periods going back a decade. I’d expect it to keep going so going forward, which makes it an excellent choice for gold bulls or those looking to hedge inflationary risk.
Vince Martin has no positions in any securities mentioned.
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