Written by: Li Xiaoyin, Wall Street News
As the Federal Reserve embarks on its first easing cycle in four years, has the stock market's rate cut trading playbook changed?
Generally speaking, when the Federal Reserve cuts interest rates to boost the economy, investors tend to choose defensive stocks and high-dividend stocks out of risk aversion and avoid growth stocks, including the technology industry, which are vulnerable to macroeconomic influences.
However, since the U.S. economy remained resilient when the rate cut took place, the rate cut resulted in technology stocks leading the way, the stock market hitting a record high, the economy continuing to grow, and corporate profit prospects improving.
Judging from the flow of funds after the interest rate cut, investors are shifting from defensive stocks to cyclical stocks.
According to Goldman Sachs Group's prime brokerage data, hedge funds bought TMT stocks (technology, media, and communications) for the third consecutive week last week, with net positions reaching the largest level in four months. At the same time, defensive stocks saw the largest net selling in more than two months, with utility stocks seeing the largest outflow of funds in more than five years.
Frank Monkam, senior portfolio manager at Antimo, said:
"The Fed's decision to cut rates aggressively when financial conditions were quite loose was a clear signal to the market that it was time to take an aggressive positioning stance."
"Traditional defensive stocks, like utilities or consumer stocks, may not be as attractive."
Why is this rate cut different from history?
Why is this rate cut called a “non-recessionary rate cut”?
According to Bank of America, eight of the nine easing cycles since 1970 occurred when corporate earnings slowed. But the current situation is that earnings are expanding, which is beneficial to cyclical stocks and large-cap stocks, Savita Subramanian, the bank's head of equity and quantitative strategy, wrote in a note to clients.
This means that the Fed is not cutting rates because of a recession, Subramanian said:
“The Fed has no playbook — every easing cycle is different.”
However, judging from historical interest rate cut cycles, each interest rate cut by the Federal Reserve tends to drive an overall increase in the market.
In the absence of a recession, the S&P has risen an average of 21% in the year following the Fed’s first rate cut since 1970, according to Bank of America.
Investment style switching: Banking, technology, and real estate are popular
So, what kind of investment style does the Fed’s “non-recessionary rate cut” bring?
As Subramanian noted, investors are moving into cyclicals, large-cap stocks and other sectors that are experiencing growth.
Benefiting from the stimulating effect of the loose environment on consumption, industries such as real estate and automobiles are also expected to grow. Phil Blancato, CEO of Ladenburg Thalmann Asset Management, said:
“You’re going to see excited consumers — lower mortgage rates are going to stimulate consumption, both in the housing market and in the auto market.”
Utilities stocks also continue to be popular in traditional trading strategies as the AI investment boom increases the appeal of the sector. In fact, utilities stocks have risen 26% so far this year, making them the second best performing industry sector in the S&P.
