5 investing ideas for rate cuts

After a drawn-out wait this year, investors who have been hoping for rate cuts may soon see their wishes granted. With inflation measures continuing to fall and unemployment ticking up, investors are broadly expecting the Fed to make its first rate cut for this cycle at its next meeting in September.

To be sure, many questions remain about the path of interest rates from here: How fast will further rate cuts follow? How low will rates ultimately fall? And will rate cuts play out against the backdrop of a soft landing, or might that long-feared recession finally rear its head?

But some good news is that falling interest rates have historically been a boon for a variety of types of investments. For investors looking to actively position their portfolios in anticipation of rate cuts, here is a look at 5 asset classes and investments that have historically performed well when rates fall. Of course, past performance is no guarantee of future results.

1. US stocks

Rate cuts have historically been a positive for the stock market broadly—a relationship that's held true, on average, regardless of whether the economy is in a recession or not.

Although stocks tend to underperform prior to a first rate cut in a recession, after a first rate cut stocks have typically outperformed over the following 12 months, in both recessionary and non-recessionary environments.

For more on US stocks, read Viewpoints: Why stocks could have room to run. Ready to invest? Find ETFs, mutual funds, or stocks with Fidelity research tools.

2. Small caps

While rate cuts have historically been positive for stocks in general, they might provide a greater boost to small-cap companies. Small companies generally carry more debt than larger companies, which means they've felt the pinch of higher rates more than their larger brethren—and could benefit more from relief on rates.

"Small caps have historically benefited more than large caps from the first rate cut of a cycle—and their advantage has been even greater when earnings also improved, as they have this year," says Denise Chisholm, Fidelity's director of quantitative market strategy.

Additionally, smaller companies have been out of favor with investors—creating a valuation gap between large companies and small- and mid-sized companies that has rarely ever been so wide. "Like gradually stretching a rubber band, I believe these factors have loaded small- and mid-cap stocks up with catch-up potential," says Chisholm. Rate cuts could provide a potential catalyst for smaller companies to come back into favor with investors.

3. Interest-rate-sensitive sectors

In particular, the real estate and financial sectors look potentially compelling, says Chisholm.

Sectors that are sensitive to interest rates, such as these 2, usually lead in the run-up to a first rate cut. "This year has been unusual because these sectors have instead lagged—performing roughly the way I might expect before an interest rate hike," she says. Both sectors have also shown low valuations, which may provide a margin of safety and indicate that the sectors are pricing in too much bad news.

Similarly to small- and mid-sized stocks, these 2 sectors appear to be potentially overdue for some catch-up, and rate cuts could provide the needed catalyst.

Fidelity research tools let you search for ETFs, mutual funds, and individual stocks to meet your sector, cap, or other criteria.

4. Investment-grade corporate bonds

Fidelity's fixed income investment team expects the Fed to take a gradual approach to further rate cuts. That could mean more opportunities for actively managed bond mutual funds and ETFs, and also continued potential opportunities for those seeking attractive yields on individual bonds. 

Bond prices and bond yields move in opposite directions. And when interest rates move down, so do yields. That means lower rates are likely to reward investors with rising bond prices. Jeff Moore manages the Fidelity^® Investment-Grade Bond Fund () and he believes that the start of rate cuts could signal a new era of opportunity for fixed income investing. 

"I think the next 2 years could be a high total return environment for bond funds," Moore says.

Investors who have enough money to build diversified portfolios of individual bonds should keep in mind that a series of shallow rate cuts may eventually reduce the yields of bonds that are available to choose from. However, those who want to add individual bonds may still be able to find attractive yields over the rest of 2024.

For more on investing in bonds, read Viewpoints: Want top rates? Consider going long. Ready to invest? To research your options, use Fidelity's Mutual Fund Evaluator, ETF/ETP screener, or individual bond research tools.

5. US Treasurys

While a gradual path to lower rates now appears likely, it is not guaranteed to be what happens. Should economic data deteriorate, the Fed could decide to proceed with deeper, faster rate cuts in order to ward off a potential recession. In that scenario, US Treasury bonds could offer investors an attractive strategy for helping manage through a potential slowdown.

Despite rising federal government debt, US Treasurys remain one of the least risky investments available, and investors are likely to continue to look to them in times of economic uncertainty.

For that reason, Treasury bonds have historically thrived when the economy has contracted. Moore believes that Treasurys could outperform corporate bonds—to say nothing of stocks—in a recession.

If the economy avoids recession, Treasurys might not outperform other bonds or stocks but could still offer a low-risk way to access attractive yields.

For more on Treasurys, read Viewpoints: Treasurys for tricky times. Considering investing? Research Treasurys.