Goldman Sachs just alerted its clients that they should start preparing for the Fed to cut interest rates this year.
The firm’s top stock strategist says investors should look to defensive healthcare and consumer staples sectors as they typically outperform the broader market following the Fed cutting rates.
“If the Fed does cut rates, the S&P 500 usually rallies afterward, with health care and consumer staples outperforming and information technology consistently lagging,” wrote Goldman’s chief U.S. equity strategist, David Kostin, in a note from Friday. The “communication services sector has generated the best relative returns and hit rate of outperformance during the subsequent 3 months (+4 pp, 100%), but has underperformed over a 12-month horizon.”
Markets are betting that the Fed will cut interest rates at least twice this year as weaker economic data and the trade war between the U.S. and China keep inflation subdued. This comes after the central bank hiked its benchmark rate four times in 2018 to a target range of 2.25% – 2.5%. The Fed’s more dovish tone sent stocks surging just above 4% last week.
Goldman also recommends momentum trades on the assumption that stocks that are currently in favor will continue to outperform, and Kostin recommends stocks that trade more calmly than others, encouraging the firms elite clients to look for stocks with low volatility.
According to Kostin, the bank’s analysis of the past 35 years showed that momentum trades have produced an average return of 13% in the twelve months after a rate cut.
“Few precedents exist during the past 30 years where futures discounted an interest rate cut 30 days prior to a scheduled FOMC meeting but the Fed did not cut,” Kostin wrote.
With lower rates, borrowing costs will shrink with typically gives companies with weaker balance sheets an advantage over those with less leverage, according to the firm. However, companies with stronger balance sheets have outperformed their weak balance sheet peers by 28 percentage points since the start of 2017, and Goldman believes that may change if the Fed begins cutting rates this year.
“We advocated for owning strong balance sheet stocks as the Fed consistently tightened policy during 2017 and 2018. However, the Fed’s dovish pivot this year and the nearly unprecedented valuation premium of strong balance sheet stocks led us to adopt a more neutral posture in February,” Kostin wrote in the note. “Elevated corporate leverage and slowing economic growth remain long-term tailwinds, but a potential interest rate cut should be a headwind to further outperformance of strong balance sheets.”
Billionaire hedge fund manager Paul Tudor Jones agrees that investors need to start adjusting what they’re doing in anticipation of a rate cut.
But Jones recommends betting on falling rates and rising gold, and says investors “should be long stocks right now,” but to bet against the U.S. dollar.
“I didn’t think we’d have a first cut in 2019,” Jones said. “I don’t think we would have had that had we not gotten into this tariff battle, and so it has accelerated everything.”
“One of the best trades is going to be gold,” Jones told Bloomberg. “If I had to pick my favorite for the next 12 – 24 months, it’d probably be gold… I think if it goes to $1,400, it goes to $1,700 rather quickly. It has everything going for it in a world of rates that are conceivably going down in the United Sates and going to zero. It has everything going for it.”