4 Stocks to Buy as the Fed Cuts Interest Rates

Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I talk with Morningstar Research Services Chief US Market Strategist Dave Sekera about what investors should have on their radars this week, some new Morningstar research, and a few stock picks or plans for the week ahead. So good morning, Dave. The Fed finally began easing monetary policy last week by cutting the fed-funds rate by a half point.

So, what did you make of Fed Chair Powell rationale for the 50-basis-point cut?

David Sekera: Hey, good morning, Susan. Maybe this is just me being cynical, but to be honest, I never really heard what I thought was a real answer during his press conference as to why he cut 50 instead of 25. I certainly didn’t hear, at least in my own mind, any answers with any kind of specificity as to why.

I actually went back this weekend and I relistened to that press conference and I still couldn’t tell you what is so different now versus the meeting in July when they had last held rates unchanged. Really at that point in time, they said they still wanted more evidence inflation would remain on the downward path. And it has.

But really, during the press conference, what I heard, and in fact, I heard multiple times from Chair Powell, he reiterated several times the labor market was in solid condition. In fact, he even mentioned that it was either at or near maximum employment, which of course is one of the Fed’s two main goals.

He noted that the economy was in good shape and growing. In fact, he forecasted that third-quarter GDP is probably running at a similar pace as to what we saw in the first half of 2024, specifically about 2.2%. And, of course, he noted that inflation continues to keep coming down. In my own mind, I think this 50-basis-point cut actually really raises a lot more questions than it does providing the answers.

Dziubinski: Now, the Fed’s dot plot showed that officials are projecting another half percentage point of rate cuts in the remainder of this year. So does that align with Morningstar’s expectation?

Sekera: It does. Now, we were only looking for a quarter-point cut here at the September meeting. But we do continue to expect that the Fed will cut 25 basis points again at each of the next two meetings. And that would bring the fed-funds rate down by the end of this year to that 4.25% to 4.50% range.

Dziubinski: Now let’s look into 2025. Unpack the Fed’s dot plot for the year ahead.

Sekera: All right. So there’s the one thing that the people always point to, and that’s the median of the Fed’s dot plot chart for the federal-funds rate. So the median right now is 3.25% to 3.50% for the end of 2025. But when I look at the dots and count them up, I would note there’s actually just as many dots at the 3.00% to 3.25% range.

So in my own mind, I really think the Fed’s really in kind of a 50-basis-point range. So somewhere in that 3.0% to 3.5% is what they’re currently forecasting by the end of next year.

Dziubinski: And where does Morningstar think the fed-funds rate will be by the end of 2025?

Sekera: Well, we’re still looking for inflation to fall below the Fed’s 2% target in 2025. That of course, then leaves them plenty of room for additional cuts, especially since we think the economy slows sequentially the next couple of quarters and really doesn’t bottom out until the first quarter of 2025. So, based on our own forecast, this 50-basis-point cut really just pulls forward one of the cuts that we expected to occur in 2025.

So our federal-funds rate is projected to drop to 3.00% to 3.25% by the end of next year.

Dziubinski: So then let’s talk a little bit about long rates. So what’s Morningstar’s forecast there for long-term rates for the next couple of years?

Sekera: Well we think right now we’re still in some of the beginning innings of a multiyear decline in interest rates. And in fact, that’s also why last fall, we recommended investors to start moving into the longer end of the yield curve, out toward like the 10-year, the 10-year back at that point in time I think was actually pretty close to 5%.

So our forecast for the 10-year is to average three and three quarter percent—or 3.75%–next year, dropping to an average of 3.25% in 2026, and then bottoming out at 3.00% flat in 2027.

Dziubinski: Now it looks like in the week ahead we have some Fed officials giving some speeches and talks, lots of those on the calendar. So it looks like we’ll be hearing more from the Fed about their thinking in the coming week. Right?

Sekera: Yeah. And I mean, I have to admit, historically, I don’t pay that much attention to the other Fed officials when they speak at the Fed meetings. I’ll leave that to our economics team. However, this time around, it’s going to be different. There are multiple different Fed officials giving speeches. And I still want to hear a better explanation from them as to why the Fed did decide to cut 50 basis points.

And I think, more than the usual I think the market will be parsing out their commentary, really trying to get a better understanding of what specifically they’re looking at. I want to hear what their view of the economy, their view of the jobs market. I also wanted to listen for indications as far as like what they’re thinking about for future cuts to the federal-funds rate, how much and how fast.

So, as you noted earlier, the dot plot projections are showing, depending on how you want to average them, one or two cuts of 25 basis points at each of the next two meetings. Yet when I look at the CME Fed Watch Tool, that indicates a 50% probability that the Fed cuts 50 basis points again at the November meeting.

So I think there’s still a lot that the market’s really trying to understand as far as what’s going on here. I’d also note Fed Chair Powell, he is scheduled to speak on Thursday at the 10th annual US Treasury Market Conference. I doubt he’s going to say anything new or different. at that point in time; maybe he tries to provide a little bit more explanation.

But to be honest, I doubt he says anything really different than what he already said at the press conference. But of course, we’re still going to have to pay attention anyway just in case.

Dziubinski: Now, what else will you be watching for this week on the economic front?

Sekera: On the economic front, we do have durable goods orders. That provides an indication of strength on the manufacturing. Typically not really a market-moving number, but in this case, the market might be more sensitive to that number if there were any kind of indications of a near-term economic slowdown. Of course, that’s on everyone’s mind right now with that 50-basis-point cut.

And then we also have the personal consumption expenditures price index. But considering the Fed just cut 50 basis points, I don’t expect to see any inflationary surprises there.

Dziubinski: So then on the economic front, do have anything else on your radar that investors should be aware of?

Sekera: I really I just got to admit, from my own point of view, I think it’s really just as clear as mud out there right now. I mean, when I think about a 50-basis-point cut here as they start to ease monetary policy, I mean, that should indicate that the Fed is more concerned about the economy and employment than inflation.

Yet, as Powell noted, the economy is still running at a very solid rate. In fact, if you take a look at the Fed GDP now, that’s running at a 2.9% run rate, indicating a very strong run rate for the economy. But then I look at other anecdotal evidence out there. So I don’t know if you noticed, but FedEx reported earnings last Thursday night. That stock fell 15% all the way down to $255 a share, which I would note is pretty much right at our fair value.

But, specifically, our analyst in his note noted that revenue missed our expectations. He called out domestic package volumes trailing our expected run rate, especially for US ground activity. And FedEx itself called out soft demand among its industrial and markets. So to me, that kind of just begs the question, is that softness idiosyncratic to FedEx or is an indication that the economy is slowing and/or that the rate of slowdown is increasing here in the short term. I’d also note UPS stock had sold off pretty hard in July after it reported earnings. So again, anecdotal evidence that the economy is slowing and maybe even slowing faster than what people may think about right now, but certainly, not anything that’s conclusive about the economy slowing more than our economic team is currently forecasting.

Dziubinski: All right. Let’s talk a little bit about some earnings news this week. There’s a few companies reporting that you’re interested in. The first being Micron. Micron looks pretty undervalued heading into earnings. Is that why you’re watching it?

Sekera: It is, but at the same point in time I think you’ve got to watch Micron. It is one of the largest semiconductor companies in the world. Now typically they specialize in memory and storage chips. Generally those are commodity-oriented. Demand will just kind of ebb and flow with the global economy. To some degree, we do think that they’re going to benefit here in the short to medium term from AI. AI data centers, of course, are being built out all over the United States and even a lot of other areas in the world. And, those data centers do require just huge amounts of data storage. Plus, we’re also starting to see PCs and smartphones that are being built to be AI-enabled as well.

They, of course, will require higher memory content, too. So our equity research team does foresee demand outpacing supply through calendar 2025. That should support high prices for Micron and relatively strong revenue growth here for, call it, the next year, year and a half. And as you mentioned it is undervalued.

It’s a 4-star-rated stock. Trades at a 17% discount to fair value. However, I would caution investors on this one. Make sure if you’re looking at it, you do realize that we don’t rate it with an economic moat. But as far as large-cap tech stocks out there, that’s one of the few that’s still undervalued.

Dziubinski: Now we also have Costco reporting earnings this week. And we’ve talked on the show before how we’re both fans of the company and frequent shoppers of those warehouses of theirs. But the stock’s really overpriced. So what are you going to be listening for as the company reports, and what’s the takeaway for investors on Costco?

Sekera: Really from my point of view I don’t see any reason why earnings aren’t going to be at least in line with expectations, if not better. But as you mentioned it’s just a matter of the stock is way too expensive. I do want to listen for any kind of commentary that they may have on the state of the consumer.

Costco really is going to serve more what I consider to be that upper middle income, lower upper income kind of demographics. So we want to listen if the pressure that we’ve seen in the lower and kind of the middle part of income dynamics are starting to work their way up or not. But it is a 1-star-rated stock. Trades at over a 70% premium to fair value, just as an indication of where that’s trading: It’s trading at 50 times this year’s projected earnings. I would just note that’s actually even more expensive than Nvidia today.

Dziubinski: Wow. So Carnival Cruise Lines also reports this week. Why are you watching this one in particular?

Sekera: Yeah, it’s another one, I just want to get an update from them on the state of the consumer that they serve. Again, it’s another one where I think they serve the upper end of the middle-income consumer as well as the lower end of upper-income consumers. So specifically, I’ll be listening: Are bookings and pricing still holding up as well as they had been for the past couple of quarters?

Dziubinski: And is Carnival stock attractive heading into earnings?

Sekera: We think so. It is a 4-star-rated stock. Trades at over a 30% discount to fair value. And this is a company that we do think has long-term durable competitive advantages. We rate the company with a narrow economic moat.

Dziubinski: All right. Well, it’s time for the picks portion of our program. This week, you’ve brought viewers for undervalued stocks to buy as the Fed begins to ease monetary policy. Now we talked about this topic, stocks that could benefit from falling rates, back in June, but given the massive rotation we’ve seen in the market since then, we’re revisiting the topic.

All right. So your first pick this week is Healthpeak Properties. Share some key metrics about this REIT.

Sekera: Still looks good in our view. It’s a 4-star-rated stock. Trades at a 28% discount, 5.5% yield. Although it is similar to most real estate or REIT companies that we don’t rate it with an economic moat.

Dziubinski: Now, REITs have staged quite a rally during the past couple of months as the market rally has broadened. Yet Healthpeak still looks really undervalued. So what’s Morningstar’s thesis on it?

Sekera: I would say the thesis overall for real estate is that real estate generally should do well in a falling interest-rate environment, which is what we expect to be in with both short term and long term rates coming down according to our projections. Real estate, of course, is highly negatively correlated with interest rates. So, as rates come down, the value of those stocks should be going up.

And the other thing, too, that a lot of people have held against the REITs for probably the past year to year and a half has been with rates being higher, people were concerned about them having to refinance that at higher rates, so with rates coming down, they’ll be able to refinance at much more attractive rates than feared even just as recently as last fall. Now, I’d note the real estate sector did surge in July and August. The sector overall is pretty close to fairly valued, but still a number of different opportunities in REITs, specifically those with defensive characteristics. Healthpeak, of course, owns a diversified healthcare portfolio of properties, mainly medical office and life sciences, a couple of senior housing facilities, some hospitals, and some things like that as well.

Taking a look at our note here, 2Q results were above our estimates. When we look at same store net operating income growth of 4.5%, that was ahead of our 3.4% estimate. So that just provided the confidence we needed at that point in time to keep our fair value steady.

Dziubinski: Now, Healthpeak has also been repurchasing shares this year, which seems like a value add given that shares are underpriced. Right?

Sekera: Exactly. So in this case, yes, that is a value add for investors. But I do need to caution investors that you have to be careful when companies repurchase stock where that stock is as compared to its intrinsic value. Oftentimes what you see happen is when companies are buying back their stock, it actually could degrade remaining shareholder value.

Oftentimes what we see is the share buybacks are at their greatest when companies are performing their best. But that’s also usually when their stock price is highest. But in this case that stock is at a very substantial discount to where we think intrinsic value is. So in this case, it is value-accretive.

Dziubinski: Now your next pick this week is another REIT, Crown Castle. Now Crown was a pick back in June, too. Shares are up I think about 18% since then. So run through some of the key stats on Crown Castle.

Sekera: Sure. As a reminder, Crown Castle’s main business is that it owns and leases cell towers here in the US. Also has a fiber optic cable business. I think they’re currently evaluating strategic alternatives. Our view is that that probably results in the sale of that part of their business. Now, while real estate overall generally does not have an economic moat, in this case, we do rate this company with a narrow economic moat.

We think the tower business will continue to keep benefiting as carriers upgrade their networks. We have the 5G rollout still ongoing. And plus, they just still need more capacity to meet the growing demand for data out there. So we forecast Crown to grow its revenue per tower at an average of 4.5% per year through 2033.

Dziubinski: So why is Crown Castle still a pick for you after the runup?

Sekera: First and foremost, it’s always still about valuation. It’s a 4-star-rated stock, trades at a 15% discount to fair value. Provides a nice healthy dividend of 5.4%. Plus, it is in the value category. And as we’ve talked about a couple of times, according to our valuations, the value category as a group still remains the most undervalued part of the market.

And so as the market continues to rotating out of a lot of those growth categories and into value, I think this will benefit from that trend as well.

Dziubinski: Now we have U.S. Bancorp as your next pick. And this is also a repeat pick from June. Stock’s up about 13% I think since you recommended it then. So what’s valuation look like today after that runup?

Sekera: I mean, certainly not as undervalued as it was back then but still trading at a 13% discount. Puts it in the 4-star territory. Another stock that has a pretty healthy dividend yield at 4.4%.

Dziubinski: So run through some of the other key stats on US Bank.

Sekera: Yeah. Just generally I would say when we look at credit metrics and capital, both are fairly good in our view. We haven’t seen any real signs of any substantial deterioration in credit quality of the past couple of quarters. Our analyst team noted that nonperforming assets are still only about a half of a percent. Common equity Tier one ratio, 10.3%.

And then the other thing I’d note here is that following the US Federal Reserve’s stress tests, the company did increase its quarterly dividend, so that also means that regulators are probably pretty comfortable with its balance sheet here.

Dziubinski: So then why does U.S. Bank remain one of your top picks among the banks?

Sekera: So it is the largest of the US regional banks. It is the only US regional bank that we rate with a wide economic moat. And to some degree, the sentiment on the US regionals is still in the process of recovering after March 2023, as you remember, that’s back when Silicon Valley and a couple of other banks had failed.

And this one still trades at an attractive margin of safety from its long-term intrinsic value. You get paid pretty attractive dividend yield while you wait for that stock to continue accreting up toward our valuation.

Dziubinski: And then your last pick this week is Evergy. Now this was a pick of yours earlier this month, too. So you must really like it, Dave. Run us through the stats on this one.

Sekera: I guess with the utilities overall being overvalued, yeah, this is still our pick here. “You must really like it”—maybe that’s a little bit of an overstatement here. But again 4-star-rated stock, 5% discount to fair value, 4.2% yield. For people that haven’t heard of it, Evergy is a regulated electric utility. It looks like it mostly serves Eastern Kansas and Western Missouri.

And in fact, looking at the utility sector with how much it’s run up thus far this year, this is really one of the last stocks, and in fact, our utility team recently highlighted it as being the last of the undervalued US utility stocks.

Dziubinski: And then remind viewers why you like it.

Sekera: So from a fundamental point of view, our team does think there’s still several positive growth drivers out there. Those improving fundamentals could actually lead management to boosting its growth outlook later this year. And if so, that actually could be a pretty good positive catalyst for the stock.

Dziubinski: Dave, thanks for your time this morning. Investors who’d like to learn more about any of the securities Dave talked about today can visit morningstar.com for more details. We hope you’ll join us for The Morning Filter next Monday at 9 a.m. Eastern, 8 a.m. Central. And in the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week.