An interesting situation

06/26/19
  • Federal Reserve has signaled its willingness to cut interest rates
  • Housing and health care could see increased trader interest
  • Not likely to be a major rate-easing cycle

Thanks to the Fed, it’s a brand-new world.

Not really. But the Fed’s transition from hiking interest rates, to putting them on hold, to possibly cutting them in the near future does have the potential to goose activity in certain areas of the market.

But it could be more of a trading thing than an investing thing.

First, no one's talking about a true rate-cutting “cycle”—that is, an extended period during which the central bank lops several percentage points off short-term rates, as it did in 1989–1992, 2000–2003, and 2007–2009. The Fed’s current stance (a stated commitment to “sustain the expansion”) is intended to provide a temporary backstop during what everyone hopes to be a transitory period of economic uncertainty.

Besides, even if it wanted to, the Fed couldn’t slash interest rates. Sure, the current Fed funds target rate of 2.5%–2.75% is near its highest level since 2008, but that’s still relatively low—in the bottom half of levels over the past 30 years.1

If the Fed follows through with rate cuts, traders may be looking for extra gains in two specific sectors.

Second, interest rates are just one factor influencing the markets, and even so-called “interest-rate sensitive” stocks can ignore changes in monetary policy if other, more immediate catalysts are in play. Maybe these stocks simply don’t read the many articles that would inform them they’re supposed to switch directions when the Fed hikes or cuts rates.

For example, “Show us the money” pointed out that financial stocks have sagged in the wake of the Fed’s June 19 statement signaling rate cuts (which adheres to the common wisdom), but it also noted that financials had an unexpectedly poor 2018 despite rising interest rates.

That said, in the event that the Fed does follow through with a limited number of rate cuts this year and the broad market (and economy) aren’t derailed by other factors, some traders may be looking for bullish opportunities in some housing and health care stocks.

LGI Homes (LGIH), Lennar (LEN), KB Home (KBH), and S&P 500 (SPX), 12/31/18–6/25/19. Homebuilder stocks price chart. Homebuilders already solid in 2019.

Source: Power E*TRADE


The housing angle is straightforward. In a declining-rate environment, housing-related stocks should, theoretically, get a bump because of falling mortgage rates—which have, in fact, recently fallen to their lowest levels since 2017.2 Interestingly, the chart above shows that some high-profile homebuilder stocks were doing pretty well this year, outperforming the S&P 500 (SPX), before possible rate cuts even entered the picture, with LGI Homes (LGIH) a conspicuous outperformer.

Then there’s health care which, despite being the weakest S&P sector so far this year, has a track record for excelling after rate cuts, with one rationale being that cuts often occur because the economy has hit a “soft patch,” and health care stocks are attractive in such situations because they tend to have consistent revenues and comparatively high dividends.3

Thermo Fisher (TMO), BioTechne (TECH), and S&P 500 (SPX), 12/31/18–6/25/19. Health care, life sciences price chart. Life sciences—hot industry in cold sector.

Source: Power E*TRADE


Be that as it may, even within the sector there are certain industries, such as life sciences tools and services, that have gotten robust health grades so far this year. The chart above shows two high-flying names in the space, Thermo Fisher (TMO) and BioTechne (TECH), which have left the SPX in the dust over the past six months.

Given the (for now) minor nature of the Fed’s rate-easing stance, investors looking for significant long-term benefits from falling rates could be disappointed. But adept short-term traders who manage their risk, focus on stocks already demonstrating relative strength, and trade selectively (i.e., buying on temporary weakness rather than chasing strength) may be able to capitalize on a possible emerging sentiment shift.

Market Mover Update: While the stock market has held its cards close to its vest so far this week, gold has been all in, with the August futures contract (GCQ9) climbing to $1,429.50/ounce yesterday. The market is up more than 12% over the past 20 days

Breakout watch: Boeing (BA) has traded in a tight range the past several days since breaking out of a larger consolidation on June 18.

Today’s numbers (all times ET): Durable Goods Orders (8:30 a.m.), International Trade in Goods (8:30 a.m.), Retail Inventories (8:30 a.m.), Wholesale Inventories (8:30 a.m.), EIA Petroleum Status Report (10:30 a.m.).

Today’s earnings include: Pier 1 Imports (PIR), General Mills (GIS), KB Home (KBH), Paychex (PAYX).

Today’s IPOs include: Cambium Networks (CMBM).

 

 

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1 FRED Economic Data. Effective Federal Funds Rate. 6/25/19.

2 Bankrate. Homebuyers and refinancers: Mortgage rates fall below 4%, their lowest point in 92 weeks. 6/19/19.

3 CNBC.com. One group of stocks has been a surefire winner when the Fed cuts interest rates. 6/18/19.

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