Sectors investors should watch if the Fed starts cutting rates

Federal Reserve Chairman Jerome Powell is testifying before the Senate for a second day, discussing how the Fed continues to consider economic data to make informed decisions about potential rate cuts. With so many different factors in mind, how could a potential rate cut play out in markets (^DJI, ^IXIC, ^GSPC) and how should investors position themselves to take advantage of it?

Brian Mulberry, client portfolio manager for Zacks Investment Management, joins Wealth! to share his thoughts on where investors should consider positioning their portfolios amid the first rate cut in current market conditions.

Mulberry explains what he continues to focus on:

“The Magnificent Seven accounted for the lion’s share of the 17% gain in the (S&P 500) index. So if those gains are going to offset, we think they’re going to come from higher quality names. It’s not going to be a ripple effect across all names because we’re still in a very high interest rate environment. And I’m just making the case right now that growth is slowing and jobs are weakening. That’s not necessarily the case where you’re going to see earnings growth in every corner of this market. So you really have to focus on what we think are the highest quality indicators…”

For more expert opinions and the latest market news, click here to watch the full episode of Wealth!

This post was written by Nicholas Jacobinoto me

Video Transcription

Investors are closely watching Federal Reserve Chairman Jerome Powell’s testimony before Congress for any hints about the timing of interest rate cuts.

They are also expecting big CP I prints on Thursday that could help the Fed develop a cuts plan.

Most traders are pricing in an interest rate cut in September.

Our next guest, however, claims that if the first interest rate cut occurs in September, it will most likely be due to a weakening labor market.

And here are some more inflationary prints.

Let’s invite Brian Mulberry, client portfolio manager at Zacks Investment Management.

Nice to have you today, Brian.

So, let’s dig into your thesis and explain why it would be more related to a weakening labor market than to inflation?

Going back to what you said, as the previous charts have shown, we are not getting anywhere near the 2% target that the Federal Reserve has set for a normal inflation environment.

So if that happens and interest rates fall sooner or later, morally it will be because the dual mandate will come into play again.

Chairman Powell mentioned this several times during his testimony yesterday.

We see greater dynamics in the labor market, namely an increase in the unemployment rate to 4.1% instead of a decline in prices closer to the target level of 2%.

The story continues

If we take into account the words of the Federal Reserve and the summary of economic forecasts, it turns out that the peak unemployment rate in 2024 will be 4.0.

We are already beyond that.

And if we were to raise the unemployment rate even further, to 4.2, then according to their own table, peak unemployment would occur in 2025.

Perhaps this is what is increasingly causing the Fed concern, not just prices.

So let’s remember that they’re most interested in full employment and stable prices, and it looks like one of those is growing more than the other. In our opinion, at least based on the current data, there’s a trend toward a weakening labor market. Where can we expect further weakening of inflation in this equation?

Especially since, as we know, the situation is more difficult, especially when it comes to issues related to shelter and energy.

Yes exactly.

These are really tough issues, just like healthcare.

We have seen significant improvements, for example in used car prices, which has an impact on the main part of the CP I report.

But it’s really the shelter issue that’s the most problematic right now, and we’ve seen waves of food inflation that have taken over one category.

A year ago it was meat and poultry.

Now.

This includes things like Coca-Cola, coffee, things like that.

So it was kind of a moving target, trying to get prices down every time one category went down and another category went up in terms of the goods themselves.

And that became a difficult, moving target that the Fed was trying to control.

So we need to see improvements in other areas to try to offset some of the shortfalls that we’ve already experienced on the food supply side.

Additionally, the second half of the year has seen some volatility among investors trying to factor this into their portfolios.

What investments and what types of investments should they look for?

Well, we think that since we’ve achieved a 17% return for the S&P 500, that’s a great year.

We would all love to book this now and call it a day.

What a wonderful year, what wonderful returns.

But this was actually due to the low number of stocks on the earlier chart.

These magnificent seven accounted for the lion’s share of the index’s 17 percent gain.

So if these gains do balance out, we think they will come from higher quality names.

This will not have a broader impact across all names as we are still in a very high interest rate environment.

Now I just want to point out that economic growth is slowing and the number of jobs is decreasing.

It is not necessary for every market segment to see profit growth.

So you really need to focus on what we think are the most important metrics, like really good and growing profits.

If S&P earnings rise by around 7%, that will be a result we want to beat.

We want this to be done without putting undue strain on the balance sheet.

So factors like low debt, high free cash flow yields and strong and growing earnings are the types of companies that will outperform their peers, but they will also be higher quality names that are better positioned for a more volatile second half of the year.

I would like to point out the lack of downside volatility we have had – we have not had a day in over a year where the S&P 520 22 index fell by 2%.

Not long ago, the market’s five worst days were all down 3% or more.

Several of them even saw a 4% decline.

So if we think about where we are today, the index would have lost more than 250 points.

I don’t think investors are ready for something like that.

We have been lulled into a false sense of security, believing that the market will continue to grow forever.

And as we know, most things revert to their mean over time, and that is exactly what we expect.