With Rate Cuts on Hold, What Should Investors Consider?

Chris Wilson, CFA Head of Global Client Portfolio Management

“Lock in current high yields for the long run and capture the ‘in-between’ price appreciation.”

High rates can soften the blow of further rate increases on bond performance—not to mention provide attractive upside if rates should fall, as they allow you to lock in current yields for the long run. If you look at today’s bonds, they offer more yield for less risk. That’s to say that the back-up in yields since 2021 has allowed investors to earn significantly higher yields relative to the credit risk of a bond issuer.¹ As a result, investors no longer need to rely on low-quality, high-risk bonds to earn attractive yields.

Also, during turbulent times in the stock market, bonds have helped reduce overall portfolio losses. In eight out of the nine years of negative S&P 500 Index returns over the last 50 years, bonds helped offset stock declines.² (2022 was the exception.) Now that bond yields have reset to significantly higher levels, we believe bonds have regained their role as portfolio diversifiers.

A common refrain we hear from investors is: “I’ll wait for the Fed to start cutting rates before moving out of cash.” But what does history show? Over the past four interest rate cycles, the yield on the 10-year Treasury peaked before the Fed started cutting rates. Those periods between the peak in yields and the first rate cut were great for bonds, which averaged a 9.4% return—capturing more than 80% of the one-year return after the last rate hike.³ In other words, investors who waited for the Fed to cut left money on the table.

James Dorment, CFA Co-Head of Fundamental Research & Portfolio Manager, Large Cap Value

“Dividend payers could benefit from a downshift in growth.”

A scenario of sustained higher rates, above-trend economic growth and more persistent inflation may boost higher-quality, larger growth stocks, which have led the market this year. But for value investors, we see an emerging opportunity in undervalued defensive names.

Defensive equities haven’t benefited from the narrative of a soft landing or potential rate cuts, and they’re generally inexpensive right now. So we think they would likely gain if higher interest rates and more persistent inflation ultimately were to lead to slower economic growth. In addition, with dividendyielding stocks lagging the market and the rising odds of a possible “no landing,” it’s possible that their compelling valuations and the increased likelihood of quasi-stagflation could make them a very attractive place to be.

Michael Coyne, CFA Portfolio Manager and Head of Small Cap Growth

“Ripe opportunities, regardless of rates.”

As we exit the Fed’s tightening cycle and anticipate future cuts, we are making a conscious effort to add high-growth stocks to fit with our philosophy. We seek out stocks with sustainable valuations and at least 15% growth potential. This is a gradual process focused more on medium-term expectations rather than the near term. In other words, we are finding attractive growth opportunities in the current environment, regardless of Fed rate cuts.

We believe the opportunity to allocate to small caps is quite compelling: Small cap growth stocks haven’t been this cheap relative to large cap growth since the dotcom bubble. The problem with investors waiting for rate cuts to materialize is that small caps can move quickly. It’s typically better to stick to your plan rather than guessing at the “perfect” entry point based on Fed rate expectations.

Barbara Reinhard, CFA Chief Investment Officer, Multi-Asset Strategies and Solutions

“A broadening U.S. equity rally and a good entry point for U.S. bonds.”

In our opinion, the number of cuts is less important than the rationale and economic data, which will ultimately dictate policy. We believe the Fed’s broader view of the economy and its longer-term guidance for the path of interest rates should persist if the inflation and employment data cooperate.

Equities: Overall, the economic soft landing and looser financial conditions, coupled with anticipated rate cuts, create favorable conditions for U.S. stocks, especially cyclical stocks, which look poised to benefit from a prolonged expansion and support a broadening rally to mid-cap and smaller cap segments of the market. Although stock prices have appreciated significantly and a near-term pullback looks possible, the accumulation of cash in money market funds points to the potential for a further rally once the Fed reduces rates.

Bonds: While higher longer-end rates make duration more attractive and provide a good entry point for fixed income investors, we think taking an upin-quality overweight to credit remains the best risk-adjusted bet. For example, investment grade credit is supported by the U.S. macroeconomic backdrop, where strong earnings suggest solid corporate fundamentals. Even if the current tight spreads widen later this year, we think the move will be limited and carry will keep total returns positive.