The Federal Reserve may not cut interest rates at its meeting next week, but Wall Street is almost 100% certain that the Federal Reserve will cut interest rates in September. This rate cut is almost certain to kick off a period of loosening, preparing for at least one more rate cut in 2024 and several more in 2025. The market is already excited about this possibility: the stock market is approaching its historical high. This enthusiasm is understandable. The unemployment rate is at a low level of 4.1%, and according to the latest forecasts from the Federal Reserve, central bankers believe that the unemployment rate will only rise slightly in 2025. Therefore, the Federal Reserve will reduce interest rates in an attempt to create a soft landing, that is, a managed economic slowdown that cools inflation (perhaps also excessive market speculation) without causing large-scale unemployment and economic recession. If it can achieve this, the stock market may soar. Anastasia Amoroso, Chief Investment Strategist at iCapital, said in a report on the market's response to rate cuts in more than 40 years: "Stocks usually rebound on the first rate cut, consolidate within one to three months after the first rate cut, and then resume their upward trend--provided that there is no economic recession." She added that defensive stocks, such as necessities, healthcare, and utilities, perform best during these cycles.

This rate cut almost certainly opens a period of easing, preparing for at least one more rate cut in 2024 and several more in 2025. The market is already excited by this prospect: the stock market is close to its historical high.

This enthusiasm is understandable. The unemployment rate is at a low level of 4.1%, and according to the latest forecasts from the Federal Reserve, central bankers believe that the unemployment rate will only rise slightly in 2025. Therefore, the Federal Reserve will reduce interest rates in an attempt to create a soft landing, that is, a managed economic slowdown that cools inflation (perhaps also excessive market speculation) without causing large-scale unemployment and economic recession. If it can achieve this, the stock market may soar.

If it can achieve this, the stock market may soar.

Anastasia Amoroso, Chief Investment Strategist at iCapital, said in a report on the market's response to rate cuts in more than 40 years: "Stocks usually rebound on the first rate cut, consolidate within one to three months after the first rate cut, and then resume their upward trend--provided that there is no economic recession."

She added that defensive stocks, such as necessities, healthcare, and utilities, perform best during these cycles.

Cohen & Steers is a company that operates mutual funds and closed-end funds invested in real estate investment trusts (REITs). Jason Yablon, the company's head of listed real estate business, said that with the prospect of lower interest rates, real estate stocks could also become attractive buying points. For fixed-income investors, stocks in the industry should be more attractive than bonds, thanks to their dividends. Yablon said that listed REITs in areas such as data centers, retirement facilities, single-unit housing rentals, and mobile signal towers look attractive and provide high dividend yields.

Note that many of these industries have lagged behind the market's gains this year, so they have even greater potential to catch up. "I'm not worried that there will be a pullback once the Fed lowers rates. We went from expecting seven rate cuts at the beginning of the year to none," said Ivana Delevska, founder and CIO of Spear Invest. "This is a disadvantage. This makes some people stay on the sidelines."

So what should investors do now to prepare for the rate cut? Sandy Villere, portfolio manager at Villere & Co., said small-cap stocks look attractive and their recent rebound has just begun. The Russell 2000 Index has risen 10% since the end of June, but its performance for the year still lags behind the S&P 500. He said: "When interest rates fall, small-cap stocks have a good tailwind." Many investors need to prepare for the rate cut. Villere said he recently bought shares in First Interstate Bancsystem, a small regional bank in Montana with a dividend rate close to 6%, and Option Care Health, a company that specializes in providing chronic disease home infusion services. But he also said that investors should look for larger, more defensive companies that can maintain strong performance even during an economic slowdown. Any examples? Republic Services (RSG.N) and frozen french fries leader Lamb Weston (LW.N).

"I'm not worried that there will be a pullback once the Fed lowers rates. We went from expecting seven rate cuts at the beginning of the year to none," said Ivana Delevska, founder and CIO of Spear Invest. "This is a disadvantage. This makes some people stay on the sidelines."

So what should investors do now to prepare for the rate cut?

Sandy Villere, portfolio manager at Villere & Co., said small-cap stocks look attractive and their recent rebound has just begun. The Russell 2000 Index has risen 10% since the end of June, but its performance for the year still lags behind the S&P 500. He said: "When interest rates fall, small-cap stocks have a good tailwind."

Villere said he recently bought shares in a small regional bank in Montana with a dividend rate close to 6%, and a company that specializes in providing chronic disease home infusion services. But he also said that investors should look for larger, more defensive companies that can maintain strong performance even during an economic slowdown. Any examples? Republic Services (RSG.N) and frozen french fries leader Lamb Weston (LW.N).

Delevska also said that technology stocks may be affected by the rate cut. This is because cash in money market accounts may flow to technology stocks along with other industries.

"If the Federal Reserve cuts rates, a large amount of funds will flow into the market, which is good for everyone," she said.

Delevska likes software stocks, whose gains are not as strong as semiconductor manufacturers such as Nvidia (NVDA.O) due to the vigorous development of artificial intelligence. She especially thinks that network security companies such as Zscaler (ZS.O), Cloudflare (NET.N), Datadog (DDOG.O), SentinelOne (S.N) and even CrowdStrike (CRWD.O) (which was recently hit hard by a large-scale global network outage) look attractive.

Vance Howard, CEO and portfolio manager at Howard Capital Management, said he likes stocks from healthcare giants like Eli Lilly (LLY.N), Regeneron Pharmaceuticals (REGN.O) and Merck (MRK.N) to software giants like Salesforce (CRM.N).

He also said that small-cap stocks that are sensitive to interest rates, such as regional banks and real estate stocks, are also cheap.

Howard said, "The biggest risk people take is not taking enough risks." The stock market may rise during the Fed's loose policy. The current environment is good.

Of course, stocks may not necessarily rise immediately after interest rate cuts. Sometimes, the expectation of interest rate cuts has already been absorbed by the market. In addition, the Fed usually cuts interest rates only in response to negative shocks, such as the internet bubble burst in 2000/2001, the global financial crisis in 2007-2008, or the COVID-19 pandemic in 2020. In these situations, interest rate cuts cannot mitigate the impact of the crisis on corporate earnings and investor sentiment.

But the Fed is not currently in a panic state. That's why once interest rate cuts begin, there may be a phenomenon of "across-the-board growth." The expansion of stock price increases, or the much-anticipated "big rotation," may really begin and continue for a period of time.

Editor/Lambor