US Equities: Beneficiaries of Fed Rate-Cutting Cycle
Exposure to defensive plays complements our long-term conviction view on technology
Chief Investment Office, Dylan Cheang28 Aug 2024
  • Rate cut imminent amid moderating inflation risks and rising downside risks to employment
  • Five to six rate cuts expected by Jan 2025
  • Historically, utilities, consumer staples, and healthcare tend to outperform 3 months after 1st cut
  • Utilities offer attractive dividend yield of 3.0%; appeals to income-seeking investors
  • From a barbell perspective, these sectors complement our long-term exposure to tech-related plays
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Dovish speech at Jackson Hole signals imminence of Fed monetary easing cycle. At the Jackson Hole conference, Fed Chair Powell announced that the time has come to adjust monetary policy amid sharp moderation in US headline inflation, which fell from a peak of 9.1% y/y in June 2022 to 2.9% in August. The Fed’s preferred inflation gauge, the PCE price index, has also touched 2.6% y/y in June. With inflation now on a clear path towards the central bank’s 2% target, Powell expressed confidence in the inflation outlook while highlighting increasing downside risk to employment.

Against this backdrop, a Fed rate cut in September is all but locked in. Based on Fed Funds futures, traders are currently pricing-in a 100% probability of one cut in September, and 31.9% chance of a second cut. A total of five to six cuts are expected by Jan 2025.  

Learning from history: Beneficiaries of Fed rate cuts in past cycles. Analysing data from the most recent four rate cutting cycles unveils that utilities, consumer staples, and healthcare have, on average, outperformed the S&P 500 by 9.0 %pts, 4.3 %pts, and 4.2 %pts respectively on a three-month basis after the initial cut. We delve into each of these sectors to explore the underlying factors driving their outperformance:

1. Utilities: The utilities sector possesses consistent revenue streams due to its provisions of basic necessities such as electricity, water, and gas. Additionally, utilities currently offer a dividend yield of 3.0% (vs S&P 500's 1.4%) and this is attractive for income-seeking investors, particularly in an environment of falling bond yields. As interest rates decline, yield-focused portfolios will progressively shift allocation from bonds to income equities and this phenomenon augers well for the trajectory of utilities companies.

2. Consumer staples: The demand for consumer staple goods is essentially inelastic as consumers still need to purchase them regardless of the economic situation. Moreover, the lower interest rate environment also reduces the interest expense of consumers, enhancing their spending power. Companies providing “value” goods selling at lower price points will benefit as consumers trade down.  

3. Healthcare: Similar to utilities and consumer staples, the demand for healthcare is broadly inelastic regardless of the macro environment and this is particularly so in an aging society. Furthermore, pharmaceutical and biotechnology companies require significant capital for R&D to drive innovation and new product creation. Moderating interest rates reduce the cost of borrowing for R&D expenditures.

Exposure to defensive plays complements our long-term conviction view on technology. Gain exposure to utilities, consumer staples, and healthcare sectors to ride the tailwinds from falling bond yields. From a “barbell” perspective, the resilient and defensive nature of these sectors complements our structural long-term exposure to technology-related plays. Despite overall growth moderation, we expect Big Tech to stay resilient given their diversified revenue streams. 

Figure 1: Outperformance of utilities, consumer staples, and healthcare post-rate cut

Source: Bloomberg, DBS


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