After several years of keeping interest rates elevated to tame inflation, the Federal Reserve finally flipped the lever the other way on Wednesday.
The central bank surprised some investors by opting for a 50-basis-point cut, lowering the federal funds rate 4.75% to 5%. The move should give a welcome boost to the economy, even though major stock market indexes gave up their initial gains by the end of that day’s session.
Still, lower interest rates are clearly a boon for a number of stocks. Let’s take a look at three that are primed to gain on lower interest rates.
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1. Home Depot
Arguably, the biggest impact of interest rate cuts is that it will lower mortgage rates and borrowing costs for homeowners. That means it’s likely to give a much-needed spark to the ailing housing market, and as rates fall, it will encourage refinancing and borrowing through home equity loans and lines of credit (HELOCs).
In fact, there’s already some evidence that the demand for HELOCs, which are typically variable-rate loans, is soaring in anticipation of falling interest rates. Additionally, homeowners have more equity to tap now due to the lock-in effect of high mortgage rates over the last few years.
This is all good news for Home Depot (HD 1.65%), the country’s largest home improvement retailer. Home Depot has struggled in recent years after the pandemic boom in home improvement spending gave way to a bust as mortgage rates soared.
The business is cyclical, and lower rates should give a boost to home improvement spending. Home Depot also has even more firepower after its acquisition of SRS Distribution earlier this year, which significantly increased its exposure to the building materials distribution sector, serving professional contractors and tradespeople.
Home Depot business is still struggling with comparable sales down 3.3% in the second quarter, but with rates expected to continue coming down, don’t be surprised if the company’s business, and the stock, are soaring by peak home improvement season next spring.
2. Carnival Corp.
Carnival Corp. (CCL 2.18%), the world’s largest cruise line operator, is a good example of a stock that’s well positioned to take advantage of lower interest rates.
Carnival should benefit in two ways. First, lower rates will lower the interest payments on its large debt balance, and possibly give the company a chance to refinance its fixed-rate debt.
The company had to go deep into debt to survive the pandemic, and it finished the second quarter with $29.3 billion in debt, which cost it $450 million in interest expense in the quarter, or $1.8 billion annualized. That equals a 6.1% average interest rate, and its interest expense ate up nearly all of the company’s $560 million in operating income in the quarter.
Even if Carnival lowered its average interest rate by 1 percentage point, it would save $180 million a year on interest expense.
The other reason why Carnival should benefit from lower interest rates is that they should boost the economy and consumer spending by helping the labor market, making it easier for businesses to borrow, and lower costs for consumers, giving them more money to spend on discretionary activities like travel.
Like Home Depot, Carnival operates in a cyclical industry, meaning the business tends to do better in a healthy and expanding economy.
3. Upstart
Finally, Upstart (UPST 4.41%) is another strong candidate to benefit from lower interest rates. As a consumer lending platform, Upstart has more exposure to interest rates than almost any other stock, and its volatile history shows that.
Shares surged back in 2021 as the company’s revenue jumped by triple digits and it put up strong profit margins. However, that boom was driven by stimulus money and the pandemic economy, and it dried up as interest rates rose and credit standards tightened.
With interest rates now falling, that unwinding should boost demand for Upstart’s loans, and loosen lending standards.
The business also seems to have improved in the meantime. Its most recent loan originations are expected to generate 14% gross returns. Its Upstart Macro Index is falling, meaning that the macroeconomy is less likely to cause a default. Ninety-one percent of its loans are instantly approved and fully automated, and it’s expanded its HELOC product to 30 states and the District of Columbia.
Management didn’t factor rate cuts into its guidance, but CFO Sanjay Datta said, “Reducing rates are unambiguously good for the business,” and added that high rates had been “the main headwind to our business.”
It’s unclear what the exact impact of lower rates will be, but Datta predicted that conversion rates, or the percentage of successful loan applications on the company’s platform, would increase with each cut from the Fed. It could take a couple of quarters for that to play out in the numbers, but Upstart stock could soar if it starts to show flashes of the company it was in 2021.
