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Fed to Cut Rates for the First Time in 10 Years: 4 Must Buys

Tirthankar Chakraborty

The Fed is widely expected to proceed with an interest rate cut by a quarter point this month after second-quarter GDP showed marks of a trade war impact on business investments and still-sluggish inflation.

Needless to say, rate-sensitive stocks usually rise when rates are declining as it eventually leads to cheaper borrowing costs. Thus, investing in real estate and utility players seems like a wise move.

Q2 GDP Reinforces Expectations of a Fed Rate Cut

The U.S. government recently reported that economic growth hasn’t slowed down as much as anticipated in the second quarter. GDP grew 2.1% in the second quarter, down from 3.1% growth in the first but better than analysts’ expectations of 2% growth, per the US Bureau of Economic Analysis.

Big spending by consumers as well as government helped the economy gain traction. Consumer spending, in particular, was up 4.3% in the second quarter, the best since the fourth quarter of 2017. Steady job additions and stubborn unemployment levels buoyed consumer spending levels. But, not everything is good about the report. Trade wars have already started to take a toll on business investments amid treats of a global economic slowdown.  

Gross private domestic investment dropped 5.5%, which includes a whopping 10.6% fall in investment in structures. While weak spending on residential construction continues to hamper growth, decline in spending on structures and equipment is more disturbing. Jon Hill, rate strategist at BMO, added that business spending took a hit not only due to trade war concerns but also because of risks surrounding Brexit and a deteriorating global economy.

(Source: US Burea of Economic Analysis)

And with trade war impacting business and trade, Fed’s desire to cut rates strengthen ahead of their next meeting on Jul 30-31. In fact, sluggish inflation increases the chances of a rate cut. The core PCE inflation, which excludes energy and food prices, rose 1.8% and was still below the Fed’s desired target rate of 2%. Lest we forget, the so-called core PCE gauge is the Fed’s preferred inflation indicator. So, as long as inflation doesn’t hit the desired target range, it’s for the economy’s best interest to help sustain the expansion is by cutting rates.

Economists, thus, largely feel that the Fed will cut interest rates by a quarter percentage point after policy makers downplayed chances of a half-point cut last week. If put into action, this will mark the first rate cut by the Fed since 2008.

Rate-Sensitive Stocks to Make Merry

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.

Top 4 Gainers

We have, thus, selected four solid stocks from the aforesaid sectors that are poised to gain from decelerated hikes in the near term. These stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).

Atlantic Power Corporation AT owns and operates a fleet of power generation assets in the United States. The stock currently has a Zacks Rank #2. The Zacks Consensus Estimate for its current-year earnings has jumped more than 100% in the past 90 days. The company’s expected earnings growth rate for the current year is 50% compared with the Utility - Electric Power industry’s projected rally of 2.4%. The company has outperformed the broader industry in the past year (+11.2% vs +11.0%).

American Water Works Company, Inc. AWK provides water and wastewater services. The stock currently has a Zacks Rank #2. The Zacks Consensus Estimate for its current-year earnings has advanced 0.6% in the past 90 days. The company’s expected earnings growth rate for the current year is 9.1% compared with the Utility - Water Supply industry’s estimated rise of 1.5%. The company has outperformed the broader industry in the past two years (+41.9% vs +35.7%).

KB Home KBH operates as a homebuilding company in the United States. The stock currently has a Zacks Rank #2. The Zacks Consensus Estimate for its current-year earnings has moved up 1.9% in the past 60 days. The company’s expected earnings growth rate for the current year is 57.3%, compared with the Building Products - Home Builders industry’s expected decline of 9.2%. The company has outperformed the broader industry on a year-to-date basis (+40.4% vs +27.1%). You can see the complete list of today’s Zacks #1 Rank stocks here.

Unitil Corporation UTL, a public utility holding company, engages in the distribution of electricity and natural gas in the United States. The stock currently has a Zacks Rank #1. The Zacks Consensus Estimate for its current-year earnings has increased 0.9% in the past 60 days. The company’s expected earnings growth rate for the current year is 4% compared with the Utility - Electric Power industry’s estimated rise of 2.4%. The company has outperformed the broader industry so far this year (+18.0% vs +14.0%).

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