Designing a Rate Cut Portfolio: Bonds, Small Caps, Energy


Most of the market attention remains with the technology sector today, where all of 2024 has been centered around every stock related to artificial intelligence, particularly those in the chip and semiconductor space. When reading this, most investors probably thought of NVIDIA Co. NASDAQ: NVDA and other names in that space, but that wave could soon be over.

The chip king has sold off over 20% in the past month, even after a recent earnings rally, leaving some in the market wondering where all this capital is headed. According to the CME’s FedWatch tool, the answer may lie with what the Federal Reserve (the Fed) is looking to do next, which involves cutting interest rates by September 2024. This is a big deal for everyone because rates tend to drive the whole market.

Those looking to position their portfolios in the best mix possible could look into the three main areas deemed ‘rate sensitive’ by fundamental reasoning and historical behavior. These three areas are government bonds, found in the iShares 20+ Year Treasury Bond ETF NASDAQ: TLT, smaller companies that rely on accommodating financing rates in the iShares Russell 2000 ETF NYSEARCA: IWM, and lastly the energy sector held in the Energy Sector Select Sector SPDR Fund NYSEARCA: XLE.

The Bond ETF Leads the Charge in Interest Rate Rotation

iShares 20+ Year Treasury Bond ETF stock logo
TLTTLT 90-day performance

iShares 20+ Year Treasury Bond ETF

$92.61

+0.81 (+0.88%)

(As of 03:40 PM ET)

52-Week Range
$82.42

$102.98

Dividend Yield
4.14%

Assets Under Management
$53.88 billion

Not many investors know the relationship between the Fed and bond yields in the treasury. To save time explaining the economics and fundamentals behind it, investors can say that it is inversely related to how the Fed feels.

When Jerome Powell expressed that he felt more comfortable with the Fed’s progress in controlling inflation, suggesting that interest rate cuts were on the horizon again, the bond ETF surged by nearly 1% in a single day.

Why? Cutting interest rates also reduces bond yields; when bond yields go lower, their prices move higher as an inverse. So, whenever investors see the Fed making a statement suggesting interest rate cuts, this bond ETF will move first.

Considering that its price today shows investors a decline of 11% on the year and over 30% in five years (to show a complete business cycle), investors can somewhat assume that the bottom could be coming soon, which will, of course, be set by the Fed’s decision to cut interest rates.

One confirmation that investors can take outside the fundamentals is the fact that Stanley Druckenmiller – the guy who traded shoulder to shoulder with George Soros – recently sold out of NVIDIA to redeploy his capital into the bond ETF alongside small-cap stocks within the Russell 2000 ETF as well, so that’s something.

Cheaper Financing Could Propel Small Cap Stocks in Interest Rate Rotation

iShares Russell 2000 ETF stock logo
IWMIWM 90-day performance

iShares Russell 2000 ETF

$201.21

-0.62 (-0.31%)

(As of 03:52 PM ET)

52-Week Range
$161.67

$211.88

Dividend Yield
1.32%

Assets Under Management
$58.93 billion

The filter to follow here would ideally be any company with a relatively small capitalization (typically defined below $2 billion) and has over 75% debt as a function of total capital to make cheaper interest rates key to financing future operations at this leverage level.

To make the job quicker, investors can look into the Russell 2000 ETF like Druckenmiller did. But for those who need a hunt and are okay with the increased risk of owning individual stocks rather than a diversified and balanced ETF, there are other stocks that could make it to a watchlist.

One of those stocks is Denny’s Co. NASDAQ: DENN; now that the stock trades near a 10x price to free cash flow multiple, analysts at Benchmark have valued the company at $15 a share, daring the stock to rally by roughly 120% from where it trades today.

Another stock on this list is Murphy Oil Co. NYSE: MUR, which investors can follow after Warren Buffett finished his nine-day buying streak of Occidental Petroleum Co. NYSE: OXY to express his bullish view on the energy sector today.

Those at Mizuho placed a $59 a share price target on that stock, daring it to rally by 44% from today’s prices. Speaking of the energy sector.

Rate Cuts Could Trigger a New Commodity Cycle for Energy

Energy Select Sector SPDR Fund stock logo
XLEXLE 90-day performance

Energy Select Sector SPDR Fund

$90.07

-1.46 (-1.60%)

(As of 03:52 PM ET)

52-Week Range
$78.49

$98.97

Dividend Yield
3.57%

Assets Under Management
$38.15 billion

There’s a reason Buffett chose oil, and it’s because when interest rates get cut. Money becomes cheaper, and businesses and consumers all around the globe will start to increase their transactional activities. For better or for worse, most of this activity relies on oil.

This new demand could prove Goldman Sachs analysts, who forecasted oil prices to reach a potential high of up to $100 a barrel this year. So far, Buffett has endorsed this view by allocating Occidental stock.

Investors can join the trend by choosing the energy ETF, in this case, given that oil and gas companies could lead the way higher.

Not only will the Fed be key here, but also trends in the ISM manufacturing PMI index, which show the oil industry as one of the few readings with a four-consecutive-month trend of expansionary activity.

“This Could Be Worth 28X More than NVIDIA” (From Behind the Markets) (Ad)

Before you consider Murphy Oil, you’ll want to hear this.

MarketBeat keeps track of Wall Street’s top-rated and best performing research analysts and the stocks they recommend to their clients on a daily basis. MarketBeat has identified the five stocks that top analysts are quietly whispering to their clients to buy now before the broader market catches on… and Murphy Oil wasn’t on the list.

While Murphy Oil currently has a “Moderate Buy” rating among analysts, top-rated analysts believe these five stocks are better buys.



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