As a value investor, I’m always looking for the best stocks to buy for my portfolio. That means looking at whether certain stocks are cheap. However, there are also times when buying stocks just makes sense because of historical trends or economic theory.
No recession, no worries
While past performance doesn’t guarantee future returns, I found an intriguing relationship between FTSE 100 shares and interest rates. Over the past five rate-cutting cycles, UK stocks have typically risen in the 12 months after the first rate cut is instigated. This pattern holds special relevance now, as the Bank of England moves towards rate cuts and the FTSE has boasted positive returns in four of the last five cycles, one year after the first rate cut.
UK stocks have shown remarkable resilience during past rate-cutting cycles, as the FTSE 100 even posted impressive gains during the 1990-1991 recession. The headline index climbed 22%+ in the year after the first rate reduction. However, British equities perform their best when a recession is avoided. In fact, returns averaged 31.5% during the 1996-1997 and 1998-1999 rate-cutting cycles.
Sector winners and their potential
So, which sectors should I be paying attention to? Well, unsurprisingly, technology stocks lead the pack historically, with a median one-year return of 37.1% during rate-cutting periods. More specifically, FTSE 100 stalwarts like RELX and Sage often outperform, as investors shift towards growth stocks in lower-rate environments.
Bank stocks such as Lloyds (LSE:LLOY) are also another hot spot. The sector follows closely behind, averaging 33% returns. This comes from the bank’s ability to lock in higher yields through structural hedges while paying less interest to customers. Banks accomplish this through investing in long-term bonds when rates are high, securing favourable returns, while reducing interest payments on customers’ savings accounts and deposits as rates drop, widening their profit margins.
What’s more, Lloyds’ large mortgage portfolio benefits from reduced default risks in a lower-interest-rate environment. And with lower rates typically stimulating borrowing activity, this usually ends up leading to increased loan volumes and associated fee income. I hold lloyds shares and am considering buying more.
Today’s investment landscape
That said, picking out specific FTSE 100 shares to buy isn’t necessarily straightforward, as past performance isn’t always an indicator for future performance. Plus the current scenario is different from past cycles. The UK market now depends more on China’s growth, faces consistent equity outflows, and is suffering from new government policies.
Nonetheless, compelling opportunities remain. Sectors such as banks and housebuilders stand to benefit from rate cuts. Meanwhile, consumer discretionary companies such as Marks and Spencer continue to show plenty of promise, as consumers tend to spend more when borrowing costs get cheaper. Plus, I’ve also got my eye on luxury as it has the potential to rebound in 2025 if the Chinese economy bounces back.
But what makes me most optimistic here aren’t just the historical trends. It’s also the fact that UK stocks continue to trade at lower valuations than their US counterparts. This pricing gap, combined with historical patterns during rate cuts, suggests FTSE 100 shares could deliver mid-to-high single-digit returns over the next 12 months, and I think stocks in the banking, tech, and consumer discretionary sectors could do just that.
