5 investing ideas for falling interest rates

After about 2 years of rising interest rates—an environment that tends to hamper performance for many investments—all eyes are now on the Fed in anticipation of rate cuts.

To be sure, many questions remain about the trajectory of interest rates and the economy this year: When might the Fed cut, and by how much? Will it cut in response to a recession, or amid continued growth? And what might the impact be on long-term rates (which are driven by market forces, and are not controlled by the Fed)?

But some good news is that falling interest rates have historically been a boon for a variety of types of investments. For investors looking to actively position their portfolios in anticipation of a turn in rates, here is a look at 5 asset classes and investments that have historically performed well when rates fall. Of course, past performance is no guarantee of future results.

1. US stocks

Falling rates have historically been a positive for the stock market broadly—a relationship that's held true, on average, regardless of whether the economy is in a recession or not.

Although stocks tend to underperform prior to a first rate cut in a recession, after a first rate cut stocks have typically outperformed over the following 12 months, in both recessionary and non-recessionary environments.

2. Small caps

While falling rates have historically been positive for stocks in general, they might provide a greater boost to small-cap companies. Small companies generally carry more debt than larger companies, which means they've felt the pinch of higher rates more than their larger brethren—and could benefit more from relief on rates.

That advantage could be particularly pronounced if the economy does avoid recession, and if small caps can deliver on bullish consensus earnings-growth estimates for 2024.

"Small caps have historically benefited more than large caps from the first rate cut of a cycle—and their advantage has been even greater when earnings also improved," says Denise Chisholm, Fidelity's director of quantitative market strategy.

Some Fidelity small cap funds and ETFs to consider include Fidelity^® Small Cap Stock Fund (), Fidelity^® Small Cap Index Fund (), and Fidelity^® Small Cap Growth Fund ().

3. Cyclical stock sectors

Falling interest rates often go hand-in-hand with rising earnings, which historically has particularly benefited cyclical sectors. The consumer discretionary, technology, real estate, and financial sectors have historically been especially likely to outperform the market when rates fall and earnings rise.

Financial stocks look particularly appealing, due to how inexpensive they've recently been. The median forward price-to-earnings ratio (P/E) among financial stocks was recently in the bottom 25% of its historical range going back to 1977. When this metric hit similar levels in the past, financials outperformed the market more than two-thirds of the time over the following 12 months.

Learn more about the outlook for sectors

4. Investment-grade corporate bonds

Falling rates may mean opportunities in actively managed bond mutual funds and ETFs. Bond prices and bond yields move in opposite directions and when interest rates move down, so do yields. That means that lower rates are likely to reward investors with rising bond prices. Jeff Moore manages the Fidelity^® Investment-Grade Bond Fund () and he believes that the eventual decision by the Fed to cut rates could start a new era of opportunity for investors who previously felt they had little choice but to either brave the volatility of stocks, or to hide in cash and let inflation rob them of their savings.

If you want to add bonds to your portfolio, consider a medium-term investment-grade bond fund which could benefit when the Fed cuts interest rates. Says Moore: "I think the next 2 years could be a high total return environment for bonds."

Explore bond funds and ETFs.

Investors interested in bonds can use Fidelity's Mutual Fund Evaluator, ETF/ETP screener, or individual bond research tools.

5. US Treasurys

If interest rates come down quickly, it will likely be because the Federal Reserve hasn't managed to engineer a soft landing for the economy and is instead trying to ward off a recession. In that environment, US Treasury bonds may offer investors an attractive strategy for helping manage through a potential recession.

Treasury bonds have historically thrived when the economy has contracted and Moore says Treasurys could outperform corporate bonds—to say nothing of stocks—in the next recession.

If the economy avoids recession, Treasurys might not outperform other bonds or stocks but would still offer a low-risk way to get attractive yields.