Economic Worries Buoy Rate-Cut Hopes: 5 Winners

A string of discouraging reports from services, manufacturing and employment has raised concerns about the underlying strength of the U.S. economy. In fact, investors are now betting that such signs of weakness would compel the Fed to lower interest rates for the third time this year in October. Needless to say, rate cuts will shore up a slowing economy. And how can we forget that the Fed has already confirmed that it will remain accommodative if the economy shows signs of prolonged weakness.

The CME’s Fedwatch indicator recently showed that almost 90.3% of investors are now expecting another rate cut in the late October meeting, up from 49% a week ago. What’s more, expectations about the central bank trimming its benchmark short-term rates two more times by the end of this year increased to 53% from 19% a week ago, added the CME Group (NASDAQ:CME).

But what makes us believe that there is an impending economic downturn? It’s predominantly last month’s deterioration of American services industries, the primary driver of the world’s largest economy.

The Institute of Supply Management reported that its non-manufacturing index slipped to 52.6% in September from 56.4% in August, as business activity, new orders, employment and imports declined, pointing to weak demand in general. The reading on non-manufacturing activity was the weakest in the last three years.

Contraction witnessed by American manufacturers coupled with a slowdown in private sector hiring raised concerns about the current state of the economy. The ISM’s manufacturing index was 47.8% for September, dropping from 49.1% in August and marking the lowest level since June 2009. In fact, American manufacturers saw their largest contraction last month since the 2007-2009 great recession.

Meanwhile, the ADP (NASDAQ:ADP) report added that the nation’s private-sector companies added a modest 135,000 jobs in September, a tell-tale sign that hiring is decelerating along with the broader economy. We should know that analysts had expected job addition of 152,000. Such a decline in private sector hiring amplified concerns that the trade war with China is certainly taking a toll on the domestic economy, let alone global conditions.

Rate Cut Might Perk Things Up for These Stocks

With a rate cut probably in the cards, shares of rate-sensitive utilities and real estate will certainly climb. This is because utilities are capital-intensive businesses and the funds generated from internal sources are not always sufficient to meet the requirements. Consequently, these companies have high levels of debt. Thus, low interest rates will help pay off debts and book profits.

However, higher interest rates along with an increase in the debt level, for that matter a steep debt/equity ratio, impact the credit ratings of these utility operators. If the credit ratings go down, a company will find it difficult to borrow funds from the markets at reasonable rates, leading to a rise in cost of operations.

Rate hikes are also a dampener to real estate activities. After all, higher interest rates will increase borrowing costs for projects, which will significantly affect companies, predominantly involved in the construction business.

If we dig into others sectors, healthcare stocks generally outperform after a rate cut. Barclays (LON:BARC) has compiled data that shows that healthcare stocks generally rise nearly 7% in the nine months following a rate cut. And what makes this set of stocks stand out is that they tend to rise consistently.

We all know that rate cuts mainly take place when the economy goes through a rough patch. And healthcare stocks have time and again thrived in such scenarios. This is because they are mostly defensive in nature as their products are not directly related to the developments in the stock market.

Moreover, healthcare stocks are known for paying hefty dividends, which makes them more alluring when rates decline in uneasy economic conditions. Needless to say, lower interest rates mostly tend to raise prices of high-yielding stocks.

Gold mining stocks also have a fair chance to gain. Thanks to the dovish expectations, gold prices are expected to rise. This is because lower interest rates tend to make bonds and other fixed-income investments less attractive. Money will flow out of bonds as they can’t provide higher yields, and in turn may flow into gold.

Top 5 Choices

We have, thus, selected five solid stocks from the aforesaid sectors that are poised to gain from an expected rate cut. These stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).

American Electric Power Company, Inc. (NYSE:AEP) engages in the generation, transmission, and distribution of electricity for sale to retail and wholesale customers in the United States. The company has a Zacks Rank #2. The Zacks Consensus Estimate for its current-year earnings has moved 0.2% north in the last 60 days. The company’s expected earnings growth rate for the current year is 4.8%, more than the Zacks Investment Research

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Written By: Zacks Investment Research