5 Stocks to Buy Before the Fed Cuts Interest Rates in 2024

Susan Dziubinski: Hello, and welcome to the Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar Research Services’ chief US market strategist Dave Sekera to discuss what’s on his radar this week, some new Morningstar research, and a few stock picks or pans for the week ahead. Good morning, Dave. Before we dive into the week ahead, let’s take a breather and talk a bit about where the market stands today.

Based on the most recent Fed meeting and on earnings season, which is winding down. Let’s start with the Fed and interest rates. Where do we stand, and what are your takeaways from the last Fed meeting from a couple of weeks ago?

David Sekera: Good morning, Susan. Good to see you. In my opinion, I think the press conference was pretty much as we expected. I thought Chair [Jerome] Powell’s commentary was essentially uneventful. I didn’t think that there was any real new news that came out of the Q&A. And I don’t think he made any significant changes to any of his prior talking points.

Now, he did acknowledge that there have been further additional modest improvements in inflation. But at the end of the day, he still thinks the Fed needs more data to put them on that path toward that 2% area that they’re looking for. Now, specifically, he did note that the recent CPI data has been more encouraging.

But then he qualified that statement by stating that the data comes after what he called several nonencouraging reports. So, I think the Fed’s still going to need to see several more reports kind of in line with that most recent CPI report before they start cutting rates. Now, as far as the economy goes, he did note that even though GDP did dip to 1.3% in the first quarter, coming down from a 3.4% rate in the fourth quarter.

He says the economy is still holding up. In fact, he pointed out that final domestic demand and really final domestic purchases--which excludes things like inventory, investment in government, and not exports--it’s still indicating the underlying demand is growing at about a 2.8% rate in the first quarter. And I think that seems to agree with our view that the economic growth in the first quarter is really probably better than that 1.3% GDP report that got printed.

Now, as far as taking a look at their summary of economic projections, that did come in slightly more hawkish than what the market was expecting. The median GDP projections were unchanged, but when you take a look at their forecast for PCE and core PCE inflation, both those actually ticked slightly higher in 2024 and 2025.

And then also unemployment in 2025 and 2026 also came in slightly higher than their prior projections. Now as far as the market, interest rates did come down pretty much across the curve, both short-term and longer-term rates. When I take a look at the CME futures market, I think to some degree that’s really discounting the Fed’s projections and what Chair Powell had to say.

I think at this point we’re still pricing in a slightly higher probability for that first cut in September and another cut in December. Both those probabilities are higher today than prior to the meeting.

Dziubinski: Let’s talk a little bit about first-quarter earnings. Were they as you expected? And what are your thoughts on how second-quarter earnings may shake out?

Sekera: Generally, I’d say the market was pretty happy with first-quarter earnings and for guidance for the second quarter. When I look at the numbers here, I’d say there’s probably pretty much a typical percentage of companies exceeded earnings estimates in line with what you see historically. Now, there was a slightly higher percentage of companies that did lower their second-quarter guidance, but not enough of an increase that I think really necessarily concerns us here in the short term.

Economic metrics are showing that second-quarter GDP is holding up. From my point of view, I think it’s still strong enough that companies should be able to easily meet or beat their earnings guidance for the second quarter. Looking at the calendar here, it looks like second-quarter earnings reports are going to start coming out maybe Friday, July 12 with some of the big mega banks and then really kick into gear the week thereafter.

Dziubinski: The stock markets have had a pretty good June. How does it look from a valuation perspective today?

Sekera: The stock market overall is still within the range that we consider to be fairly valued. But I’m going to note it’s really starting to get into the higher end of that range. So, not necessarily in overvalued territory just yet but definitely starting to feel pretty stretched. Now having said that, it kind of feels like there’s a pretty good potential here over the next month for maybe a summer meltup in the market.

When I take a look at things like the upward momentum, the economy’s still holding up, inflation moderating, interest rates declining, three or four more weeks until earnings reports really start to roll in. It wouldn’t surprise me just to kind of see how maybe this slow grind over the next three to our weeks, really no other new catalysts that I’m really looking at that I think really could end up whacking the market in the short term.

Dziubinski: Then what are the risks to the market today, Dave?

Sekera: I think the risks really come up when companies start reporting the second-quarter earnings, but specifically the guidance that they’re going to give either for the third quarter or for the second half of the year. I think the risk would be over the next couple of weeks, depending on what management is seeing in their own individual businesses and fundamentals, is the economy maybe starting to slow enough?

Or maybe we start seeing some things that could pressure management teams to maybe provide guidance that could be lower than Street expectations. I’d say earnings are probably the biggest short-term risk. Other than that, if inflation fails to moderate or it doesn’t stay on that downward path that could maybe scare the market a little bit, that maybe the Fed doesn’t start to cut in September. And, of course, just generally if the economy were to slow faster than expected. Now, one new risk that I’ve really kind of been starting to keep my eye on. And in fact, I’m not actually even necessarily sure exactly how it could necessarily be a risk to the US market. But I’ve been watching the Japanese yen, and I’ve been looking at the charts there, and the Japanese yen has really been weakening. It’s weakened 13% versus the US dollar just this year. But since the beginning of 2022, it’s weakened almost 40%. And it’s actually the weakest foreign-exchange rate since the mid-1980s.

Now, of course, Japan is the fourth-largest country in the world by GDP. But being a small island nation, it has to import almost all of its raw materials. So again, I’m getting concerned, not necessarily sure exactly how all that could work out, but it’s starting to be something I’m keeping my eye on. The other thing I’d note with Japan, you know, their 10-year bond over there is still yielding below 1%.

There’s approximately 10 trillion of Japanese bonds outstanding. So, between the weakening of the exchange rate if we were to start to see yields on their bonds increasing very quickly, then of course, the Japanese banks that own a lot of those Japanese bonds could start having some embedded losses on their balance sheets that could pressure their ability to fund loans out there.

So, again, I’m starting to get concerned, but it isn’t necessarily something that really figured out just how that could play out over the next couple of months or quarters.

Dziubinski: Interesting. Let’s get to what’s on your radar this week, specifically. And we have a few earnings stragglers, starting with Carnival Cruise Lines CCL. Why is this one you’re watching?

Sekera: Carnival is a 5-star-rated stock that trades at a 40% discount to fair value. It’s a stock that I think over the past year or two, we’ve highlighted a number of times as being significantly undervalued and an interesting opportunity. Now, I think you and I have talked multiple times over the past month or so that in the first-quarter earnings reports, while inflation has already negatively impacted lower-income households, we’re really just now starting to see that compound impact of two years of inflation really starting to hit middle-income households now consumer products that are considered indulgent or those that are most discretionary have been affected the most thus far. But talking to our analytical team, they’ve noted that travel thus far has held up pretty well. So, I want to see if that’s still remaining true for the cruise lines or if we start to see consumers start to pull back on vacation plans as well.

Dziubinski: Any other companies reporting this week that you’re keeping an eye on?

Sekera: The two I’m going to be watching most closely are going to be General Mills GIS and Nike NKE. Now, General Mills, we have also highlighted a couple of times. It’s a 4-star-rated stock, trades at a 14% discount to our fair value, and yields 3.5%. It’s a company with a narrow economic moat. So, I think for certain types of investors it might be an interesting opportunity.

What I’m looking for here is whether their margins have turned the corner and started to improve. A number of food companies have started to turn that corner. So, we’ll be looking to see if General Mills is also following that pattern. But I also want to look at the composition of their organic growth, if there’s really been much of a trade-off between the volume and their pricing strategy, as they’ve been putting price increases through to customers, as well as what’s going on with the promotional environment.

Are food companies using price to fight for market share at the expense of margin, or are they more focused on margin and keeping their earnings up? And Nike I think we talked about relatively recently. Another stock that looks pretty attractive here. Nike is interesting when we look at the stock trading pattern over the past four years.

Initially that stock surged in 2020 and 2021. And a lot of that was just because we had such a huge shift during the pandemic into goods and away from services. In fact, that stock went up so much that it went well into 2-star, or overvalued, territory. But then that stock started to slide in 2022.

And that’s just because consumer spending patterns started to normalize and go back toward services and away from goods. So, at this point when I look at the chart, Nike stock has given up all of the gains that it had made since the pandemic. It’s actually back to prepandemic levels.

Now, we’ve talked about how middle-income consumers are feeling the pressure from inflation. But when you listen to earnings calls from Nike, it sounds like they’ve already planned for weak consumer demand at least through the first half of fiscal 2025. So, really I’m looking much more for are they really on track for still meeting kind of our longer-term forecasts for this company?

When I look at our financial model here, our analyst has average sales growth of about 5% over the next 10 years. And then we’re also looking for a gradual recovery in operating margins to get back toward where they’ve been historically. So, over the next 10 years, we have them generally increasing getting back to those normalized levels.

Currently, it is a 4-star-rated stock trading at a 25% discount and only yields 1.5%. So, maybe not necessarily a pick for dividend investors, but for investors that like some yield but are looking for that discount, this could be an interesting opportunity.

Dziubinski: And on the economic front, we have the PCE number coming out this week. And as a reminder, as you mentioned earlier, the PCE is the inflation metric that the Fed watches most closely. What’s the market expecting?

Sekera: Right now, the consensus for headline PCE on a year-over-year growth basis is 2.6%. That’s a slight decrease from the 2.7% reading that we had last month. But even more important is going to be the core PCE number. So, the Fed and even our US economics team really look at that core reading as a better reading for longer-term inflation trends.

Right now, that consensus estimate for core PCE on a month-over-month basis is for a one tenth of a percent increase. That’s a slight decrease from two tenths of a percent reading last month. If we do get that slight deceleration, that should help provide the Fed with some of that additional confidence that they’re looking for, that the rate of inflation is on that slowing path.

Dziubinski: Let’s move over to some new research from Morningstar. Morningstar recently raised its fair value estimate on a stock that you’ve recommended a couple of times this year. That’s Adobe ADBE. So, why did Morningstar raise the fair value? Is the stock still attractive? Because the stock did pretty well since reporting earnings earlier this month.

Sekera: First of all, I probably should just mention that yes, we did increase our fair value, but it really wasn’t that much of an increase. We just took it up to $635 a share from $610. And essentially when I look at our note and our model here, it looks like we tightened up our short-term forecasts just because the company did report relatively solid second-quarter results, and they slightly raised their outlook for the full year. But our longer-term assumptions and projections are essentially unchanged. As you noted, the stock did pretty well since the earnings report it’s up 16%. But really that just recuperates the loss it had from earlier this year after it reported its first-quarter results.

Back then, if you remember when we talked about the first quarter, really the reason it sold off wasn’t because they didn’t have decent earnings, but it’s because management wasn’t very clear in their outlook and their guidance. And we think the market overreacted at that point in time to you that potential kind of hiccup in management’s relaying how they were thinking about the market and how they were seeing their fundamentals.

So, the stock is still attractive to us. It’s a 4-star-rated stock and trades at a 16% discount. And I think it looks like, based on the chart, it has some pretty good momentum going into the summer.

Dziubinski: Speaking of some stock price bounces, Apple AAPL stock is up quite a bit since the firm held its Worldwide Developers Conference earlier in June. What did Morningstar think of the event? Any impact on our outlook? And is the stock still overvalued today?

Sekera: That stock has risen enough now and especially after the conference. It’s a 2-star-rated stock and trades at a 22% premium to our fair value. So, it’s getting up there as far as I’m concerned. We left our fair value unchanged at $170 per share. In our opinion, nothing really changed from that conference.

Reading our note here, that Apple Intelligence Week is kind of within the expectations of what we were thinking about prior to the conference. We didn’t make any changes to either our short-term or our long-term forecast. So, to be honest, I’m not really sure what the market is seeing here.

Dziubinski: Kroger KR reported earnings last week. And this is a company that you said you were interested to hear from largely for a read on the health of the middle-income consumer. Did you glean anything from Kroger’s report about that?

Sekera: Unfortunately, I didn’t. I think it’s really the same kind of story that we’ve seen here before that they did note that some of that food inflation is weighing on middle-income consumers as well. But unfortunately, I didn’t really get any strong takeaways here one way or the other from Kroger. So, I still think that middle-income households are starting to feel the pressure, feel the hit from inflation, but it’s not necessarily really moved into the food component of spending just yet. It’s really still much more with the discretionary and the more indulgent items that people spend money on.

Dziubinski: Now Kroger stock pulled back a bit after earnings. Is there an opportunity here for investors after that pullback?

Sekera: It’s really going to depend on the type of investor. Personally, I don’t see a lot of attraction here in Kroger. I’ve got other areas that I’m much more interested in that trade at bigger discounts to fair value than Kroger.

Dziubinski: Morningstar recently upgraded the economic moat ratings on a couple of companies. Before we get into those specific companies, Dave, remind viewers what Morningstar’s economic moat ratings are and what types of things might trigger a change in an economic moat rating.

Sekera: An economic moat is really just a very Warren Buffett or a Graham and Dodd-esque type of analysis. We’re trying to determine does a company have a long-term durable competitive advantage that’s going to allow that company to generate excess returns on invested capital over their weighted average cost of capital for long periods of time.

We always start off assuming that a company does not have an economic moat. So, even if they are generating those excess returns today, we expect that competition will see that and generally compete away those excess returns over the next three to five years. Now, if a company does have these long-term durable competitive advantages, and we think those excess returns will last for probably the next 10 years or so, that’s when we’re going to award a company with a narrow moat.

And in order to get that wide moat, companies are going to have to generate those excess returns for at least the next 20 years. And of course, the longer a company can generate excess returns, the greater the present value of its intrinsic valuation.

Dziubinski: The first moat upgrade is actually a stock that Warren Buffett owns a lot of, so it’s kind of interesting that you mentioned him. It’s Kraft Heinz KHC, and we’ve talked about the name on the show before. Morningstar upgraded the company to a narrow moat rating from a no-moat rating. What drove this upgrade?

Sekera: Kraft, when it was bought out by 3G Partners maybe around a decade ago at this point, I think the company shifted its focus and overemphasized short-term profitability at the expense of building long-term economic value. Initially, that did start to work, but then that stock did start to slide in 2018 and 2019 as the impact from that short-term focus really began to erode its underlying fundamentals and business.

Now, over the past five years, Kraft has gone back. They revamped their strategy really to refocus on building long-term value, specifically by looking to improve efficiencies, reinvesting in its brands, and improving its category management. At this point, we think the company is back on the right track. The changes it’s made have strengthened its intangible assets, such as its brands, but it’s also really strengthened its cross structure enough to have a low-cost, durable competitive advantage.

At this point, it’s really just a matter that it’s increased our confidence enough in their ability to generate those excess returns on invested capital over that 10-year time period. And so we did go ahead and increase the moat to narrow.

Dziubinski: Were there any changes to Kraft Heinz’s fair value estimate related to the upgrade? And is the stock still undervalued today?

Sekera: We did. We increased our fair value to $57 a share, which puts it in that 5-star territory. It trades at a very deep 40% discount to our fair value and also paid about a 5% dividend yield. So, I think this is a pretty attractive stock from a couple of different points of view.

Dziubinski: Morningstar also recently upgraded the economic moat rating on NXP Semiconductors NXPI to wide from narrow. And we also increased the fair value estimate by around 10%. Why the moat upgrade on this company and is the stock attractive?

Sekera: I think generally the upgrade here is really just a result of having an increase or a greater confidence in two of its different moat sources and how long those moat sources are going to help them generate those excess returns. First of all, just taking a look at their intangible assets, I think we’re recognizing some of the strength around its expertise and its chip designs and some of the ability that they have to keep ahead of their competitors there, but also from benefits from the high switching costs embedded within their products.

Essentially, once their parts are designed into a customer’s end products, it’s very difficult for companies to be able to switch out to competitive chips. So, net-net, we did increase our fair value to $57 a share, which puts it in that 4-star territory as it trades at a 15% discount to fair value. Only a 1.5% dividend yield, but at the end of the day, based on where things are trading in the market, this is really one of the few tech stocks that’s still in that 4-star territory.

Dziubinski: All right. Time to move on to the stock picks portion of the program. But before we do, though, I’d like to address a viewer question that came in this week. And it was from a viewer in Portugal. He asked, “How long does it typically take for a stock pick to play out?” Put another way, what should an investor expect the holding period to be for one of your stock picks, Dave?

Sekera: This actually makes me think of a famous quote from Ben Graham. And of course, Ben Graham is literally the person who wrote the book on security analysis. And that quote is, “In the short run, the market is a voting machine. But in the long run, it’s a weighing machine.” Essentially what that means is that in the short term, there can be a lot of noise out there that affects both the market sentiment as well as individual stock prices.

And that’s really a large part of the reason why we think a stock price can be significantly different than its long-term intrinsic valuation, whether overvalued or undervalued. I think what you need to remember is what we focus on here at Morningstar is really trying to identify those stocks that we think are trading at a significant risk-adjusted discount to our long-term intrinsic valuation.

These are stocks that are intended to be investments and not necessarily your short-term trades. If you’re looking for short-term trade ideas, to be honest, this isn’t the right show for you. Now, sometimes it works out more quickly, and the market comes around to our point of view and things trade up or trade down toward our fair value.

But other times it might take a lot longer. Sometimes it might even take up to a couple of years that we can see the markets starting to look through that short-term noise and properly value a company based on its ability to generate free cash flow over the long term.

So, again, it’s always hard to know. Sometimes they work out pretty quickly. But other times it’s taken maybe two years before you kind of get through that short-term noise and really get toward that intrinsic valuation.

Dziubinski: All right. Let’s get on to this week’s picks. As you mentioned earlier in the show, Morningstar still expects the Fed to begin cutting interest rates this year, so you’ve brought viewers five stocks to buy before the Fed begins cutting rates. Your first two picks are REITs, which are interest-rate sensitive, so they should do well when rates fall.

The first REIT pick is Crown Castle CCI. Why do you like it?

Sekera: I also like this one because it actually kind of further bolsters how you have to look through the short-term noise in the marketplace and you can have a stock price that differs from intrinsic valuation for multiple years in a row. This is actually a stock that was rated 1 or 2 stars for multiple years before it began to trade down in 2022 and 2023.

I mean, in 2020 and 2021, we just really couldn’t understand what the market was thinking and why it was at such a high valuation. And now at this point, kind of from where the peak of the stock was at the end of 2021, it’s now fallen over 50%. We think it’s now fallen too far to the downside. Crown Castle owns over I think 40,000 cellphone towers has 85,000 miles of fiber, generates just generally very steady cash flows from customers with investment-grade-type profiles like AT&T T and Verizon VZ.

A 4-star-rated stock, trades at a 26% discount, and currently yields about 6.5%. And it’s a company that we have a Medium Uncertainty Rating on. So, I think it’s a very attractive candidate for interest-rate cuts.

Dziubinski: Your second pick this week is Realty Income O, which you’ve recommended more than once before. What’s to like here?

Sekera: Well, as you said, real estate is inversely correlated with interest rates. This stock fell throughout most of the second half of 2022 and in 2023 as interest rates have risen, I think it’s down about 30% off of its mid-2022 high. Now, generally, it really hasn’t been much of a change in the fundamental tolls over the past year and a half.

So, we think the stock is just falling too far compared to those fundamentals. We’re generally still pretty comfortable. Whereas I think Wall Street just because they hate real estate so much. I’d still steer clear of urban office space. But real estate with defensive characteristics just had been brought down with the overall real estate sector.

In this case, Realty Income is a triple-net-lease provider. That means they have the ability to pass through inflationary costs directly to their tenants. They have very long leases. I think that lowers the risk of maybe near-term lease reductions if the economy starts to soften.

Plus, the tenants here generally are pretty defensive: gas stations, drugstores, things like that. So, generally a pretty strong fundamentals to the downside even in a potentially softening economic environment. And lastly, I’d note this was one of our top picks by our equity analyst team in our second-quarter outlook. Overall, it’s a 5-star-rated stock at a 30% discount and yields about 6%.

Dziubinski: Your next two picks up from the utilities sector, which is also known for being interest-rate-sensitive. Your first pick is a stock we talked about recently on the show, WEC Energy WEC. Remind viewers why you like it.

Sekera: The utilities sector sold off way too much last year as interest rates were rising. It got to, I think last October at some of the most undervalued levels that we had seen over the past decade. Since then, the utilities sector overall has been performing pretty well. We’ve seen a lot of good gains there. WEC stock, for some reason, has really been what I consider to be a pretty mediocre performer compared to the utilities sector over the past several months.

To be honest, I don’t really understand why it’s lagged over that time period. Generally, our team thinks that they have a very constructive regulatory environment for stockholders. We think it’s actually a very good play as far as trying to play that increase in electric demand to power growth in data centers for artificial intelligence. It’s a 4-star-rated stock at a 19% discount.

We rate it with a narrow economic moat and a Low Uncertainty. The stock yields about 4.25% right now. Overall, we think it combines best-in-class management as well as above-average growth opportunities and a constructive regulatory environment. So, long term I still think it’s probably one of the better beneficiaries out there. And we’ve seen a lot of people talk about how AI data centers require a lot more electricity demand than traditional data centers.

And we see there’s a number of data centers that are currently under construction in Wisconsin because, of course, that colder environment up there in the northern states means it costs less to cool the data center. So, again, I think that’s a really attractive opportunity for investors to look into.

Dziubinski: Your second pick from the utilities sector is Entergy ETR. Looks like Morningstar recently ticked up its fair value estimate on the stock a little bit. Is Morningstar expecting this utility to benefit from that data center expansion, too?

Sekera: It will to some degree. Amazon AMZN is building a $10 billion facility in Entergy’s Mississippi service area. And we estimate data center expansion could add 10% or more to their capital investment plan in 2028 and beyond. But generally, I still think the story here is more of being an attractive utilities play just based on the combination of growth, valuation, and dividend.

We did bump up our fair value slightly to $126 a share from $123. Overall, it’s a 4-star-rated stock at a 16% discount, 4.3% dividend yield. And, like most utilities, it also has an economic moat.

Dziubinski: And then your last stock to buy before the Fed begins cutting interest rates is U.S. Bancorp USB. Why?

Sekera: Well, bank funding costs have remained elevated, I think, for longer than people expected because the Fed has kept those short-term rates much higher over the course of this year than what people were necessarily expecting coming into the year. And looking at the banks, I think there’s still a lot of concern about the increase that we’re seeing in write-offs and defaults.

But, in our view, they’ve really just been rising up to much more normalized historical levels after having been low during the pandemic. So, U.S. Bancorp has long been one of our banks among the US regionals. Now, again, it’s no longer anywhere near its lows. That hit last year after the Silicon Valley Bank bankruptcy, but it’s still a 4-star-rated stock at a 25% discount, 5% dividend yield.

It’s a company we rate with a wide economic moat. In fact, I think it’s the only regional bank that we rate with a wide moat, and it has a Medium Uncertainty as well. So again, there could be some near-term choppiness among banks until the Fed starts to cut rates this fall. And I think the market needs to get more comfortable that while default rates increase we’re not expecting them to surge that much higher.

I think this is an attractive, solid pick in order to play those short-term rates coming down.

Dziubinski: Well, thanks for your time this morning, Dave. Viewers interested in researching any of the stocks that Dave talked about today can visit Morningstar.com for more analysis. We hope you’ll join us for the Morning Filter again next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week!