After a long wait, it seems that September will be the moment when the Federal Reserve will begin its interest rate cut program.
In fact, the market is currently expecting 5 consecutive meetings with rate cuts and a total reduction of two percentage points for the next 12 months.
The rest of the major central banks in the world, except Japan and Australia, already began their first rate cuts months ago. In the case of the ECB, it is expected that this week it will decide to undertake its second rate cut this year.
It has been 14 months since the last time the organization chaired by Jerome Powell raised interest rates to the level of 5.5%, being the second longest period since 1970 between both movements (the historical average is 8 months), and this change of scenario opens a new horizon for our investment strategies.
Market developments after the first cut by the Fed
Historically, in the 12 months following the start of interest rate cuts by the Federal Reserve at the end of a rate-hike cycle, the average return on U.S. stocks has been 11% above inflation. Stocks have also outperformed government bonds by 6% and corporate bonds by 5%, on average. Cash and very short-term bonds, meanwhile, have returned 2% above inflation.
Returns above inflation by asset class 12 months after rate cuts began
However, if we compare stocks and bonds over the course of this century, we can see that this dynamic is reversed and bonds have performed better on the last three occasions when the Fed decided to raise rates and then cut them. It should be noted that during 2001 and 2007 these decisions were taken at a time when the financial markets were at the beginning of two of the biggest stock market crises in history, the dotcom bubble and the subprime mortgage crisis.
Total return of the S&P 500 and Bloomberg US Aggregate Bond index in the 12 months following a rate cut. Source: Charles Schwab
Some sectors that could benefit from interest rate cuts
There is a certain consensus in the market that the luxury sector withstands periods of crisis more solidly than other industries. This, they argue, is because the consumers of these companies are much less sensitive to economic crises and therefore demand withstands these processes.
However, this is not entirely true and we would have to go to specific segments of the fashion sector to see this supposed resistance. In fact, we could argue that the luxury sector is one of the main beneficiaries of low interest rates and monetary injections (in colloquial terms, we could call it money printing or even helicopter money).
The target market of the luxury sector is mainly focused on the wealthiest population. So much so that ultra-luxury could be focused on billionaires.
Well, if we look at the evolution of the M2 monetary aggregate (the sum of cash, demand deposits, savings deposits, interest-bearing deposits of less than 100,000 and money in monetary funds of individuals), which is a way of representing the money supply, and compare it with the evolution of the total wealth of the richest 0.1% and 1% in the United States, we obtain a practically perfect correlation.
This relationship would refer to the Cantillon effect, which states that the effect of monetary policy is not distributed evenly, but that new money reaches some sectors or assets before others. This means that the main clients of companies in the luxury sector are indeed greatly benefited by monetary stimulus, which leads us to think that the demand for luxury products is also conditioned by these stimulus.
We therefore believe that the reduction of up to almost 5% in M2 that we experienced from the highs of 2022 to the end of 2023 (which has since begun to recover slightly) has been impacting the luxury sector in recent quarters. Note that this is not something isolated to the United States, but that practically all economies in the world have made adjustments of this type.
Therefore, the interest rate cuts that we will see in the coming months may be the origin of good financial results for companies in the luxury sector throughout 2025 and beyond, as has occurred in other economic cycles. Although the sector will probably continue to be damaged by the economic situation in China, the rebound in other geographical areas may provide a boost to their shares.
Real estate sector
The real estate sector is one of the biggest beneficiaries of the rate cuts. In particular, we think that the residential segment will do best, especially in Spain. It should be noted that buying a home requires a significant investment, which is why most investors choose to go to a bank to request financing.
Therefore, the level of interest rates is key to the evolution of the real estate sector. High interest rates mean higher financing costs, which also reduces the demand for properties. On the other hand, low rates allow for cheaper financing and encourage demand for properties.
Furthermore, the value of a property, like that of most assets, is based on the present value of its future cash flows (rent collected or future value of the property). These flows are brought to the present at a discount rate that is highly related to interest rates. Therefore, a reduction in rates means a higher value for properties, which is usually reflected in the markets, that is, in the price of the property.
But the two fundamental variables that determine the final price of a property, supply and demand, are also influenced by other factors. Specifically, in Spain and more specifically in large cities, the number of inhabitants is growing more and more, which implies a greater creation of new homes and therefore a greater demand for properties, whether to buy or rent.
In fact, it is expected that between now and 2030 the resident population in Spain will increase at a rate of 1% per year, which if we combine it with the trend of migratory flows towards large cities, we can assume a much greater growth in the main Spanish capitals.
This trend clashes head-on with supply, which is constrained due to regulations and has been lower than demand in recent years. This can be seen in the comparison between households created and new homes, with the former being higher than the latter since 2018, reaching a ratio of 0.6 homes built for each household created. Or what is the same, for each new household created in that period, 1.66 families have competed, which has driven up the price of housing and rent.
Specifically, from 2014 onwards, the price of housing began to accelerate and even during the pandemic, when the purchase and sale of housing fell by up to 50%, prices rose. In addition, price growth frequently exceeds 5% compared to the same period of the previous year, reflecting a trend that is difficult to stop due to the lack of measures by the entities in charge.
If housing prices have continued to rise with high interest rates, it is normal that with lower rates they will rise even more.
For all these reasons, we believe that companies that promote, build or manage a property portfolio will benefit greatly from the rate cuts.
Technology sector
One of the great friends of low interest rates is the technology sector. This is also based on the theory we have developed for the real estate sector on the value of an asset. But in the technology sector it also has another interpretation. Low interest rates not only increase the value of assets (due to a lower discount rate) but also encourage investors to take on more risks in search of returns that fixed income does not provide in that environment.
This is when the technology sector emerges, which by its disruptive nature has an inherently high risk, but offers attractive potential. This means that when interest rates fall, a large part of the market throws itself into technology companies.
Furthermore, when interest rates fall and fixed-income profitability is reduced, investors are more willing to finance long-term projects in search of future benefits. This leads to the financing of companies that do not generate profits at present but that increase their income at very high rates, which means a promise of future profits. In this sense, within the technology sector we find numerous companies with this pattern, so they will also benefit from the interest rate cuts.
In fact, in the last year in which a cycle of rate cuts began, 2019, the profitability of the technology sector was 49.8% compared to the rise of the S&P 500 of 31.5%. This does not mean that in the next quarters we will see a rebound of such magnitude, but it does create the breeding ground for it.
Silver
Bonds and indices have shown a higher correlation than usual in recent years, so incorporating some alternative assets such as raw materials into our investment portfolios can help us reduce risk.
Demand for silver has grown in the last year, mainly led by the renewable energy and photovoltaic sector. The growing global shift towards renewable energy sources is driving demand for silver, with solar panel companies projected to account for 20% of global silver consumption, compared to 5% in 2014. In recent weeks we have seen a major recovery in the sector due to the expectation of upcoming rate cuts, due to their high levels of indebtedness and which would allow for the manufacture of new projects, favoring silver consumption.
Among the main effects of this change in monetary policy by the FED, we consider that the dollar could suffer a correction in its value, while the markets could find a new catalyst that helps them break their historical highs again. Silver is the raw material that has shown the greatest decorrelation with the dollar, also trading in a positive trend with the rise of the world markets.
India, one of the countries that will have the most growth in the coming years, has broken its historical record of silver imports, while other key countries also demand a greater quantity. The world’s largest power, the United States, is improving in the jewelry industry; in the case of China, it is due to the rise of the electronics industry, while the European locomotive, Germany, is in the automotive sector.
Investors often turn to precious metals to protect their investments in times of uncertainty. When traditional currencies face challenges and risks, assets such as gold and silver stand out as a reserve of safety. Furthermore, the fall in bond yields due to the change in central banks’ monetary policy could favor their attractiveness given that none of them pay interest.
The gold/silver ratio is currently trading at levels close to 90, which has historically reflected that silver could be undervalued, taking into account that its average for the last 10 years is 77.
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