4 Ways Investors Are Playing The Fed Rate Cut

The Federal Reserve's decision cut the benchmark federal funds rate for the first time since the 2008 financial crisis is leading investors and investment advisors to reconsider their portfolio allocations, especially in light of widespread expectations that more rate reductions may be ahead. “It’s made me change what I’m doing,” said Pat Savu, a retired engineer. “Treasurys are really stable but they don’t pay, ” she added, noting that she now is buying individual municipal bonds and municipal bond funds which yield 4% or more.

In addition to municipal bonds, investment professionals are recommending mortgage funds, consumer stocks, and high-yielding stocks in response to the Fed's rate cut, according to a detailed story on the shift in The Wall Street Journal.

Significance For Investors

David Romhilt, chief investment officer (CIO) at New York-based Summit Trail Advisors, says that his firm recommends moving out of short duration securities that are sensitive to changes in the Fed's interest rate policy. They also advise shifting from corporate credit to mortgage funds that should get a boost from falling interest rates, which are likely to bolster home prices and spur the refinancing of mortgages, according to the Journal.

 “You’re not being compensated for the risk,” Romhilt said regarding falling yields on corporate bonds. Meanwhile, he believes that mortgages which survived the financial crisis are stress-tested. He also recommends medium-term and long-term municipal bonds, suggesting the Vanguard Intermediate-Term Tax-Exempt Fund (VWITX) and the Vanguard Long-Term Tax-Exempt Fund (VWLTX).

The average rate on the benchmark 30-year fixed-rate mortgage recently was 3.97%, versus 4.75% a year ago, a 52-week average of 4.54%, and a 52-week high of 5.10%, according to Bankrate.com. Despite a 1.4% downtick in total mortgage applications for the week ending July 26 versus the prior week, applications to purchase homes are up by 6% year-over-year (YOY), while applications to refinance are up by 84% YOY, the report notes.

David Lefkowitz, senior equity strategist at the wealth management division of UBS Group AG, expects lower interest rates to boost the economy and lengthen the bull market, per the Journal. He recommends consumer stocks whose sales should get a lift from lower borrowing costs, as well as defensive stocks with attractive dividend yields in the consumer staples, health care, telecom, and utility sectors.

As a means to build a diversified portfolio of income-producing stocks, financial advisors at UBS often use the iShares Select Dividend ETF (DVY), Lefkowitz added. This fund had a 30-day yield of 3.74% as of June 30, per iShares.

Consumer staples stocks have been the second-best performing sector in the S&P 500 over the past three months, behind information technology, per another Journal article. Their recent dividend yield of 2.8% was exceeded only by energy and utilities stocks, according to data from FactSet Research Systems cited in the same report. The 10-Year U.S. Treasury Note currently yields 1.98%, per CNBC.

Looking Ahead

As an alternative to bonds, high-yielding defensive stocks have the added attraction of the potential for future dividend increases. Most bonds, such as the T-Note, have fixed interest rates. However, the rate cut by the Fed does not eliminate that dangers to stock prices posed by a slowing economy and unresolved trade conflicts.