The most recent economic data suggests the Fed’s inflation problem is starting to ease. That’s got investors excited about the prospect of the Fed’s rate hikes being on pause. Most people see a black and white relationship when it comes to interest rates and the stock market — rates rising is bad, rates coming down is good. But the situation is more nuanced than that. If you’re looking for stocks to buy to capitalize on the end of rate hikes, here are a few things to consider.
Right now the consensus is that the Fed will pause its rate increases and start to cut rates come summer. This may not necessarily be a good thing for investors. That’s because although inflation would be under control, a rate cut suggests the economy is struggling. Central banks tend to cut rates when economic growth is stalling— that’s a bad thing for most businesses. Slowing economic growth means jobs are scarce, income is stretched and consumers are unwilling to open their wallets. So, in this kind of environment it makes sense to own more defensive stocks — like defense companies and utilities.
But what if it’s just a pause? If the Fed takes a prolonged break hiking interest rates but doesn’t move to slash them, it suggests inflation is under control and the economy is still running hot. This is good news for businesses, because it means people aren’t worried about losing their jobs and demand should remain relatively firm. In this scenario, the best stocks to buy are those in the consumer discretionary sector and those that have a high-growth mentality.
There are a lot of reasons to pick Costco (NASDAQ:COST) as one of the best stocks to buy. The big-box retailer has a business model that many retailers would kill for. Costco looks more like a subscription service than a retailer, given the bulk of its profits come from its membership fees.
This membership-based model has a few key advantages. The first is profit. New members are virtually cost-less to add, so most of those dollars drop straight through to profits. This means Costco can afford to relax a little when it comes to growing its merchandise sales. The membership model also means Costco customers are stickier. If you’re paying $60 per year for the privilege to shop at Costco, you’re likely to choose that store over another when it comes time to do your weekly shop. All that time shopping at Costco builds your trust in the brand, which translates into a renewal rate of over 90%.
But why Costco now? Because it’s a consumer discretionary stock with a layer of security. If the economy is on firm ground and consumers decide to go wild, Costco will benefit. But if the bottom falls out, Costco’s low-cost model and grocery offerings mean it fits into the “necessities” category too.
In a worst-case scenario in which the Fed is forced to cut rates thanks to a painful economic slowdown, the best stocks to buy are those with relatively guaranteed income. The defense sector offers that— governments aren’t going to loosen the reins on national security even when times are tough. This makes defense sector stocks a relatively safe place to hide through periods of economic uncertainty.
BAE (OTCMKTS:BAESY) is one of the best quality stocks to buy within the defense sector. The group makes heavy duty military equipment and its government contracts stretch well into the future. That means revenue is relatively visible and reliable. BAE’s got a sizable order book worth just shy of £60 billion and that’s expected to grow further this year.
Of course, inflation is a thorn in BAE’s side – the group has to estimate future costs accurately in order to protect profitability. Energy cost fluctuation and supply chain snags have been the main source of uncertainty lately. However the group’s balance sheet is in good shape, giving the group flexibility to grow promising areas like cyber intelligence.
Amazon (NASDAQ:AMZN) stock has fallen almost 40% from its 2021 level. This is thanks to an increasingly uncertain environment and the Fed’s rate hikes, making it a stock to buy in any environment. Rising interest rates change the way stocks like Amazon are valued because a dollar’s worth of earnings in 10 years time is suddenly worth less today than it was a few years ago.
While its valuation has changed, Amazon’s growth story remains the same— and it could be in for a boost if interest rates are slashed. The group’s retail business could struggle if a recession is in the cards, but there are other parts of the business to be excited about. Cloud computing is among the most interesting growth stories for Amazon, with AWS dominating the market. The cloud market is expected to grow by 14% per year through 2030, leaving space for AWS to expand.
Advertising is another place Amazon has a lot of growth potential on tap. Given that people searching Amazon are typically already ready to buy, the friction between seeing an ad and buying a product is relatively low. That should appeal to advertisers, particularly if they’re on a tight budget. It helps them get more bang from their buck.
On the date of publication, Marie Brodbeck held BAE and Costco. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines