One of the most anticipated moments in the market would be the announcement of a rate cut by the United States (US) Federal Reserve (Fed). In the recent Fed meeting held around a week ago, they are expecting to go through three rate cuts in 2024. This news had sent the markets to a rally (at least for the US and our local Straits Times Index). While we feel some exuberance over this, we need to be cautious, too, on how the actual thing may unfold in the months to come on interest rates. Below I will describe four snippets on why we should not be too held up by excitement and exercise some prudence in our investment decisions.
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#1: Markets Are Forward Looking
This is typically a given, as expectations are a major driving force in determining the market sentiment. Some of these expectations are calculated by analysts, e.g., a fall in x% in interest rates would reduce y% of interest costs of a company or industry, thus providing an additional z% of profits. Other expectations, however, are fuelled by blind optimism which are usually baseless and this may cause them to be overblown. If the super-optimistic target is not reached after reality sets in (e.g., rate cuts did not happen, see #2), then the price or index will fall hard.
#2: Rate Cuts Expected
When one expects something, the person is holding the hope that it should happen. As this is real life and not a fairy tale, the word “hope” is one of the dangerous words to use in investing, for one does not know whether it will happen or not. It is important to know that the Fed makes interest rate decisions by looking at economic data such as inflation and unemployment. A plan is made when certain conditions are met, but if during its execution something else crops up then it must be readjusted. This meant there is a possibility that the Fed may rescind on their three-cuts schedule.
#3: Cuts Are Not Drastic
Even with rate cuts imminent, it is likely not going to be reduced by a huge number each time. The Fed had mentioned that the cut, if it comes, would be on a gradual approach, so if the no-cut scenario in #2 does not happen, then it is probably a gentle step-down rather than a big drop.
#4: Effects Of Cuts Take Time
Though a rate cut signifies cheaper borrowing costs, this effect takes time to realise as some of the current debt held by companies and real estate investment trusts (REITs) were based on rates during the last couple of years. This means at least for another year or two, the companies and REITs are shouldering the high cost of borrowing until the debt could be swapped or restructured to the current lower rates. Hence, looking out for strong balance sheet and cash flow are important during one’s analysis of a security in question, like whether it can sit out comfortably in the next few years or so.
What Now?
REITs had been hammered, and treasury bills and fixed deposits were getting popular in the last two years, all thanks to a high interest rates. If you are an active investor, and if your portfolio allocation allows it, you may want to consider looking at the above two, for the former they may not stay low for long, and for the latter they may not stay high for long. For REITs, as I had highlighted in #4, it is preferable to go for the healthy ones, like with lower gearing and in a region/country/sector which is thriving come rain or shine, e.g. Singapore retail scene, provided the price is right.
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