Following its meeting earlier this month, the Federal Reserve has announced its decision to maintain interest rates, keeping the federal funds rate within the 5.25% to 5.5% target range.
This is the 4th time in the last five meetings where the Fed has opted to keep rates unchanged, despite having raised them 11 times in the ongoing economic cycle to counteract high inflation. Hence, the market has started to assume that the Fed is “done” raising rates as they have now brought inflation under control.
Many factors affect how interest rates change. However, it’s clear that these changes have a big effect on certain stocks, particularly on companies that use borrowed money for their daily activities or to grow. This is especially true for growth stocks.
In anticipation that interest rates will go down soon, I share 5 stocks that I had bought this month.
But before that, here’s:
Why does the market thrive in a low interest rate environment?
While the entire stock market tends to move higher in a low interest rate environment, certain stocks tend to benefit more. Such companies tend to require debt to fund their operations, and having low interest rates means they can do so at a much lower cost.
Imagine this.
You’re starting a business and you want to borrow $10,000 from the bank. If interest rates are 5% per annum, you would be paying $500 in interest. But if interest rates are at 0.5% per annum, you would only be paying $50 in interest! Hence, you would surely be more inclined to take up a loan when interest rates are lower.
The difference in costs tends to be more significant for companies that have not yet achieved profitability. They tend to be “reliant on debt” and fund their operations by taking on loans. Of course, companies that are profitable may also borrow money to fund additional R&D or expansion.
Hence, having lower interest rates generally allows the market to have a more growth-oriented mindset allowing for increased bullishness amongst investors.
The best case study – ARK Innovation ETF (NYSE : ARKK)
The ARKK ETF is perhaps the best example to illustrate the inverse relationship between growth stocks and interest rates. As you can see from the diagram above, when interest rates went down, the ETF went up. Likewise when interest rates went up, the ETF crashed.
You see, ARKK ETF contains many unprofitable growth stocks that rely heavily on debt to finance their business. As such in a low interest rate environment, many of these companies find themselves loaded with ample cash because not only do they increase borrowing, but their investors also borrow money to invest in them.
It’s not conclusive to say if this is a good or bad business practice. However, we can take advantage of such market conditions as investors.
5 Stocks I bought this month
In anticipation of future interest rate cuts, I’ve rebalanced my portfolio and trimmed some of my gains from the Magnificent 7 stocks such as Amazon and Alphabet.
This doesn’t mean that big technology companies’ stocks are done for. However, investors have been really into these stocks in 2023. So, with the changing winds, there’s a chance these stocks might not do as well in 2024.
1) Unity (NYSE : U)
Unity is the biggest portion of my latest buys. A 3D Platform, Unity was hot on the market during their IPO as they started trading in an environment with almost 0% interest rate. The stock had rallied from $60 to $200 at IPO. Unity has since retreated to below its opening price and is currently trading at $40+.
Unity has been through its fair share of drama with their recent pricing controversy.
Unity CEO John Riccitiello steps down following controversy over the engine’s pricing. The timing of his departure may be linked to the backlash.
The controversy began when it was announced that games made with Unity would be charged a fee for downloads after certain thresholds were passed. This caused outrage among developers.
Protests and boycotts from developers led Unity to change its pricing structure. Fees will no longer apply to previous builds, and only games with over $1 million in revenue will be charged.
Unity CEO is Stepping Down Following Pricing Controversy – Gamerant
Long story short, they wanted to earn more money but their customers (businesses that use their platform to build games) were not happy with their methods. The news of their change in pricing structure caused their stock to crash by almost 20% ! Seeing the drop, investors quickly started buying, which stabilized the share price on the same day.
With improving earnings and a recent upgrade to a Zacks Rank #2 (Buy), I continue to remain bullish on Unity.
2) Shopify (NYSE : SHOP)
In recent weeks, Shopify’s price action has experienced significant momentum. SHOP 2x its share price within a 1 month!
Propelled by an outstanding third-quarter financial report that surpassed Wall Street expectations, the company achieved a revenue of $1.7 billion, marking a 25% year-over-year increase. With improving forward-looking guidance, SHOP’s management anticipates a mid-20s percentage increase in revenue for the full year of 2023.
It is important to note that Shopify’s growth in 2020 and 2021 was largely fueled by heightened e-commerce activity resulting from lock downs during the pandemic. While major lock downs are unlikely to occur again, it is likely that discretionary spending would increase in a low interest-rate environment causing this company to see similar growth.
3) The Walt Disney Company (NYSE : DIS)
No secret here but amongst the stocks that I’ve added to, Disney is probably the odd child, given that they are profitable and have much stronger fundamentals than all other cash-burning companies that I’ve included here.
Assuming they sort out their internal problems (declining content quality, involvement in politics, cash-burning initiatives such as Disney+ etc.), the bull case for Disney is that a reduction in interest rates may see discretionary spending increase.
For the same reason that businesses borrow more money due to lower interest rates, individuals too would also borrow more money either in the form of loans or leverage. Hence with more cash on their hands, it is likely that Disney may see an increase in their theme park revenue and respective experience segments.
Price-wise, they currently trade close to their 7 year lows where while still risky, is a price point that I find incredibly attractive.
4) NIO Inc. (NYSE : NIO)
A rather contrarian move, NIO is an incredibly high risk-to-reward play.
NIO is trading at almost 80% off their all-time highs with the stock price floating below $10 at present. Those who traded NIO back in 2020 would be well aware of how “hot” the stock was when interest rates were almost 0%. There is a likelihood that such momentum can return should interest rates start declining.
Bull case-wise, despite lagging behind their competitors, NIO announced that they signed an investment deal with Abu Dhabi-based CYVN Holdings worth $2.2 billion. This would make CVYN the largest individual shareholder of NIO taking their ownership up to a fifth of the company (20.1%). This deal would give NIO the much-needed cash to support their operations for the next 2 years. Lets hope that CYVN has certainly done more through due diligence than us retail investors have.
5) ARK Innovation ETF (NYSE : ARKK)
There are similarities between what I’m seeing today and that of what happened to ARK right before interest rates were brought to 0%.
While I’m personally a fan of Cathie Wood, I bought ARKK ETF because I believe that it is likely to outperform other instruments in a low-interest rate environment. Recent trades Cathie Wood also suggest that they are loading up on companies that did well previously in 2020.
Will I be rich if interest rates get to 0%?
Despite the active management of my personal stock portfolio, I believe that investing should never be about trying to predict what interest rates would be. I personally consider growth investing to be extremely risky as we’re investing based on what may happen in the future (speculative) rather than what has happened (fundamentals = factual).
While it is fun to try predicting future events like interest rates, the bulk of our investing should be based on solid fundamentals—real, factual information about a company’s current and past performance.