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Written by: Chandler Nichols | Advisor Asset Management
With above-trend growth in the air, the market feels a little like it’s riding a wave of optimism. Key economic indicators are signaling resilience: real GDP growth is tracking better than expected, inflation is moderating toward target levels, the labor market remains robust with low unemployment, and consumer confidence continues to support steady spending. Despite these favorable conditions, the Federal Reserve is poised to lower interest rates — a move typically reserved for sluggish economies. This proactive decision reflects an intention to maintain economic momentum and guard against potential lagged effects of their recent hiking policies of 2022 and 2023. For investors, this combination of strong economic signals and rate cuts could bring new opportunities for those looking to expand both sides of a multi-asset portfolio in ways that go beyond the usual into areas such as thematic growth equities and preferred stocks.
Key Takeaways
1. Lowering interest rates with above-trend growth, declining inflation, a strong labor market, and high consumer optimism may bode well for investors seeking to increase risk appetite.
2. Interest rate cuts will likely have income-focused investors seeking tax-efficient alternatives, with low duration preferred stocks standing out as a compelling option.
3. Above-trend growth, bolstered by corporate investment into technologies like artificial intelligence (“AI”), may make thematic growth strategies focused on disruptive technologies a compelling opportunity.
Riding the Economic Wave: How the Fed’s Rate Cuts Could Boost Investor Confidence
When the Fed signals its cutting rates in a strong economic setting, it can act like fuel for the risk-taking side of investing. The backdrop of above-trend growth, reflected by a recent advance estimate of 2.8%, year-over-year, real GDP growth for Q3 2024 along with an upward revision to 3.0% for Q2 2024, suggests that the economy is providing a solid footing for corporate growth.1 Inflation, while moderating, is trending closer to the Federal Reserve’s target 2.0% target level, further supporting the Fed’s consideration to pivot to a dovish stance for labor market considerations.
Adding to this are strong labor market conditions. While the unemployment rate has increased from 3.4% to 4.1%, this is still below the 40-year median of 5.5% and 1 standard deviation below the 40-year average.2 This, in turn, supports consumer confidence, which has remained robust as spending continues to be the backbone of the American economy. While the decision to lower rates may be seen as a preemptive move, there are considerable opportunities to consider.
Past performance in not indicative of future results.
Interest Rate Cuts and the Appeal of Preferred Stocks
With the Fed cutting rates, income investors are going to have to consider, once again, alternative opportunities to maintain payment streams. More importantly, tax efficiency will be a key focus. Preferred stocks are particularly compelling in this environment with relatively dependable income streams to that of common equity holders, given their priority in the capital structure, while still maintaining the potential for qualified dividend tax treatment. For those seeking consistent income without relying solely on traditional fixed income, whose coupons are typically taxed at ordinary income tax rates, preferred stocks present a unique and appealing solution.
Low duration preferreds add an extra layer of risk management, sporting a face value screen in which unattractively valued preferred stocks are removed from the portfolio to assist in volatility reduction. While adding low duration preferreds to a broad fixed income portfolio exhibits higher marginal volatility on an after-tax basis, the after-tax return margin increases more so.
Past performance in not indicative of future results.
Moreover, recent volatility in the banking sector has heightened investor weariness regarding equity investments within the space. Preferred stocks can potentially serve as a more defensive approach. Preferred market fears have continued to drop too in which option-adjusted credit spreads of low duration preferreds have fallen 270bps from the end of the March 2023, the month of the regional banking crisis, to the end of October 2024.3
The Capital Expenditure Boom is Expected to Benefit Non-Technology Sectors
Amid this strong economic backdrop, capital expenditures (capex) among major companies, including the so-called “Magnificent Seven,” are soaring. In 2024 alone, these tech giants are expected to contribute over $200 billion in capex, largely fueled by investments in artificial intelligence (AI) and supporting infrastructure.4 However, the reach of these investments extends far beyond technology alone. The push for AI and other advanced technologies requires a vast economic value chain, driving demand in sectors such as real estate, materials, and utilities.
- Real Estate: Data centers will be the backbone to the AI theme as hyperscalers seek to expand their computing capabilities. North American data center supply grew by 24% year-over-year in H1 of 2024.4
- Materials: Copper will be a central component of data center buildouts. Data center copper use may be around 1.1 million tons by 2030.5
- Utilities: Demand for electricity from global data centers may double by 2026, consuming the same amount of electricity as the entire nation of Japan. This brings energy solutions such as nuclear power and natural gas into the forefront of the conversation.6
This interconnected growth suggests a next wave of expansion for companies as the full economic ecosystem aligns to support the rising needs of AI and other high-demand technologies. For investors, this represents an opportunity to capture value across a diversified range of industries that are poised to benefit from this capex-driven momentum.
Past performance in not indicative of future results.
Conclusion
Today’s economic landscape presents investors with the chance to reshape their strategies and go beyond the ordinary. Rate cuts in a high-growth economy could mean a stronger appetite for risk, while income-focused strategies like preferred stocks offer tax-efficient ways to meet income demands. At the same time, the thematic growth potential of transformative technology investments like AI offers the promise of tomorrow’s leaders. By blending these opportunities thoughtfully, investors can create portfolios that not only grow with the times but are poised to thrive as new trends emerge.
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1Source: U.S. Bureau of Economic Analysis, as of 10/30/2024.
2Source: AAM with data from FRED measured monthly from 10/1984 to 10/2024. U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, November 5, 2024.
3Source: ICE Data Indices LLC, measured point-in-time on 03/31/2023 and 10/31/2024.
4Source: CBRE. (2024, August 19). North America data center trends H1 2024.
5Source: Bloomberg. (2024, July 15). Copper demand is set for data-center boost.
6Source: AIBusiness. (2024, June 04). AI Workloads to Double Data Center Power Demand by 2026.