Chances of a rate hike in the Federal Open Market Committee's (FOMC) policy meeting next week receded significantly following weak jobs data and comments from Fed Chair Janet Yellen. Surprisingly, lower-than-expected data raised speculation among investors that the Fed may not opt for a rate this month. This is because labor market conditions are one of the key indicators that the Fed considers while deciding on a rate hike.
While the financial sector is likely to be negatively impacted by this low-rate environment, some of the broader sectors including gold, utilities, and real estate are poised to gain. This may provide an excellent opportunity to invest assets in mutual funds from the above-mentioned sectors in order to boost their portfolio in a low-rate environment.
June Hike Unlikely
Though the minutes of April's FOMC policy meeting showed that a notable number of Fed officials were optimistic about a rate hike this month, the possibility dimmed since the release of the jobs data last week. On Monday, Federal funds futures - a well-known indicator of a rate hike possibility - showed that chances of a rate hike in next week's meeting is 2%, significantly lower than 15% indicated a month ago. Concerns over a rising possibility of a Brexit also lowered the chances of a hike.
Meanwhile, Yellen maintained a cautious tone regarding the pace of rate hikes and said that if the Fed "were to raise interest rates too steeply" and "were to contribute to a downturn," then it would have "limited scope for responding." Though Yellen said that most of the U.S. economic data has been encouraging following which the Fed will increase rates this year, she refrained from giving any clue to the timing of the hike. She also said: "One development that could shift investor sentiment is the upcoming referendum in the United Kingdom... A UK vote to exit the European Union could have significant economic repercussions."
Major Reasons for Lower Chances of Hike
The Bureau of Labor Statistics (BLS) reported that the U.S. economy created a total of only 38,000 jobs in May, significantly lower than the consensus estimate of 203,000. It was also the lowest increase since Sep 2010. Moreover, the labor force participation rate declined to 62.6% as 458,000 individuals quit jobs or gave up job searches. This led to the decrease in the unemployment rate to 4.7% in May, which is the lowest level since November 2007.
Separately, a rise in the possibility of a Brexit also played a significant role in reducing the rate hike chances. By the end of this month, the UK will finalize whether it will remain in or leave the European Union (EU). In a plebiscite on June 23, votes in favor of or against Brexit will be requested. Most of the recently released polls on the referendum showed that there is a strong possibility of a Brexit. While five out of the eight most recently published surveys showed that percentage of people supporting Brexit exceeded those who are against it, only two indicated that Brexit may not happen.
Sectors to Gain from Low Rate
Gold witnessed a strong surge in prices in recent times following dimming hopes of a rate hike this month. Gold has had a dream run since the start of this year on the back of its safe-haven appeal. The commodity is poised to continue with this positive trend for as long as the low interest rate environment prevails. Lower interest rates generally tend to boost gold, as it makes yield-bearing assets such as U.S. Treasuries less attractive. Lower rates also affect the dollar, which in turn increases the appeal for precious metals like gold.
Utility is another safe-haven sector that got a significant boost from the low-rate and volatile environment since the start of 2016 and emerged as the best performing sector among the S&P 500 sectors this year. Utility companies are one of the major beneficiaries of a low interest rate scenario. This is because higher rates raise their financing costs, which eventually reduce their appeal as dividend investments. Utility companies also boast predictable cash flows and generally pay out dividends. Since utility companies are mostly regular dividend payers, they are often regarded as "bond substitutes."
Another sector that is poised to gain from this low-rate environment is real estate. A low interest rate environment brings golden opportunities for REITs, which are required to distribute at least 90% of their annual taxable income to shareholders annually in the form of dividends. Thus, a low interest rate environment increases the lure of high yields delivered by REITs and vice versa. Meanwhile, recently released encouraging housing data indicated that the housing markets are witnessing strong signs of improvements. This positive trend is likely to continue in the low-rate scenario as the cost of taking loans will remain low.
6 Mutual Funds to Buy
We have selected two mutual funds each from precious metals, utility, and real estate categories that either carry a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy). We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund.
Moreover, these funds have encouraging year-to-date and one-year returns. They also have the minimum initial investment within $5000, low expense ratios and no sales load.
Precious Metals Funds
The American Century Quantitative Equity Funds Global Gold Fund (MUTF:BGEIX) invests in securities of global companies whose operations are related to gold or other precious metals. BGEIX with a Zacks Mutual Fund Rank #1 has an annual expense ratio of 0.67%, lower than the category average of 1.45%. The fund has year-to-date and one-year returns of 88.5% and 41.7%, respectively.
The Fidelity Select Gold Portfolio (MUTF:FSAGX) invests heavily in common stocks of companies whose principal operations are related to gold as well as bullion or coins. FSAGX with a Zacks Mutual Fund Rank #1 has an annual expense ratio of 0.93%, lower than the category average of 1.45%. The fund has year-to-date and one-year returns of 76% and 40.6%, respectively.
The American Century Utilities Fund (MUTF:BULIX) invests a major portion of its assets in equity securities of companies engaged in the utilities industry. BULIX with a Zacks Mutual Fund Rank #1 has an annual expense ratio of 0.67%, lower than the category average of 1.15%. The fund has year-to-date and one-year returns of 17.4% and 18.3%, respectively.
The Fidelity Telecom and Utilities Fund (MUTF:FIUIX) invests the majority of its assets in securities of telecommunications services and utility companies. Sporting a Zacks Mutual Fund Rank #1, FIUIX has an annual expense ratio of 0.74%, lower than the category average of 1.15%. The year-to-date and one-year returns of FIUIX are 16.5% and 9.7%, respectively.
The Fidelity Real Estate Investment Portfolio (MUTF:FRESX) primarily focuses on acquiring common stocks of companies involved in operations related to the real estate domain. Also sporting a Zacks Mutual Fund Rank #1, the fund has an annual expense ratio of 0.78%, lower than the category average of 1.29%. FRESX has year-to-date and one-year returns of 6.4% and 17.3%, respectively.
The T. Rowe Price Real Estate Fund (MUTF:TRREX) invests the lion's share of its assets in real estate companies including REITs. This fund has a Zacks Mutual Fund Rank #2 and an annual expense ratio of 0.76%, lower than the category average of 1.29%. TRREX has year-to-date and one-year returns of 3.5% and 11.8%, respectively.
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