After years of keeping interest rates high to curb inflation, the Federal Reserve finally reversed course on Wednesday.
The central bank surprised some investors by opting for a 50 basis point cut, cutting the federal funds rate from 4.75% to 5%. The move should provide a welcome boost to the economy, even though major stock market indices gave up their initial gains by the end of the day’s session.
Still, lower interest rates are clearly a boon for some stocks. Let’s take a look at three that are poised to benefit from lower interest rates.
1. Home Depot
The biggest impact of rate cuts is likely to be that they will lower mortgage rates and borrowing costs for homeowners. That means it will likely provide a much-needed boost to the ailing housing market, and as rates fall, it will encourage refinancing and borrowing through home equity loans and lines of credit (HELOCs).
There is even some evidence that demand for HELOCs, which are typically variable-rate loans, is rising in anticipation of falling interest rates. In addition, homeowners now have more equity to tap because of the lock-in effect of high mortgage rates in recent years.
This is all good news for Home Depot (NYSE: HD)The nation’s largest home improvement retailer, Home Depot, has struggled in recent years after a pandemic boom in home improvement spending turned into a slump as mortgage rates soared.
The business is cyclical, and lower rates should boost home improvement spending. Home Depot also has additional firepower after acquiring SRS Distribution earlier this year, which significantly increased its exposure to the building materials distribution sector, which serves professional contractors and tradespeople.
Home Depot’s sales are still struggling, falling 3.3% in the second quarter. But with tariffs expected to continue falling, don’t be surprised to see the company’s sales and stock surge toward the height of the DIY season next spring.
2. Carnival Corp.
Carnival Corp. (NYSE: CCL)the world’s largest cruise line, is a good example of a stock well positioned to benefit from lower interest rates.
Carnival should benefit in two ways. First, lower rates will reduce interest payments on its large debt balance and potentially give the company a chance to refinance its fixed-rate debt.
The company had to go deep into debt to survive the pandemic, ending the second quarter with $29.3 billion in debt, which cost it $450 million in interest expenses in the quarter, or $1.8 billion on an annualized basis. That works out to an average interest rate of 6.1%, and the interest expense ate up nearly all of the company’s $560 million in operating income in the quarter.
Even if Carnival were to lower its average interest rate by 1 percentage point, the company would save $180 million annually in interest expenses.
The other reason Carnival should benefit from lower interest rates is that it would boost the economy and consumer spending by stimulating the labor market, making it easier for companies to borrow money and lowering costs for consumers, leaving them with more money to spend on leisure activities such as travel.
Like Home Depot, Carnival operates in a cyclical industry, meaning it tends to do better in a healthy, growing economy.
3. Parvenu
Finally, Upstart (NASDAQ: UPST) 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 rose again in 2021 as the company’s revenue grew by triple digits and it posted strong profit margins. But that surge, fueled by stimulus money and the pandemic economy, petered out as interest rates rose and lending standards tightened.
With interest rates falling, that settlement should boost demand for Upstart loans and ease lending standards.
Things seem to have improved in the meantime, too. Its most recent loans are expected to yield 14% gross. Its Upstart Macro Index is falling, which means the macro economy is less likely to default. Ninety-one percent of its loans are approved instantly and are fully automated, and it has expanded its HELOC product to 30 states and the District of Columbia.
Management did not factor in rate cuts in its forecast, but CFO Sanjay Datta said: “Cutting rates is definitely good for the business,” adding that high rates were “the biggest headwind for 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 Fed cut. It could take a few quarters for that to show up in the numbers, but Upstart shares could soar if it shows flashes of the company it was in 2021.
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Jeremy Bowman has positions in Upstart. The Motley Fool has positions in and recommends Home Depot and Upstart. The Motley Fool recommends Carnival Corp. The Motley Fool has a disclosure policy.
Interest Rates Are Falling. 3 Top Stocks to Buy Now was originally published by The Motley Fool
