With inflation cooling and central banks signalling potential rate cuts, investors are wondering whether lower interest rates could fuel a stock market rally. Historically, declining interest rates have acted as a positive catalyst for equities due to several reasons.
First off, lower interest rates translate to reduced borrowing costs for businesses. Furthermore, lowering interest rates also tends to improve consumer confidence. In addition, as interest rates decline, stocks typically become more attractive compared to fixed-income investments.
This is why, when economic numbers such as jobs reports have been positive lately, it’s negatively impacted markets. In the near term, the stronger the economy appears, the better the chance that inflation will remain higher, meaning the longer it will take for central banks to ultimately lower rates.
However, while lower interest rates generally provide a tailwind, not all sectors benefit equally.
Source: Getty Images
How lower interest rates affect the market
When interest rates decline, borrowing becomes cheaper. This, in turn, encourages businesses to expand and invest in growth. Consumers also tend to spend more, boosting corporate earnings and supporting higher stock valuations.
Additionally, as I mentioned above, lower rates make bonds and other fixed-income investments less appealing, pushing more capital into the stock market.
However, the impact of rate cuts can vary depending on economic conditions. If central banks lower rates due to a slowing economy, stocks may initially struggle before rebounding.
But if rate cuts come alongside stable economic growth, markets could experience a sustained rally.
This is why central banks have to be so careful and why policymakers have been hoping for a soft landing over the last few years.
Without a steady decline in interest rates, the economy could worsen, which could lead to a recession and a stock market correction.
Should we get the soft landing that most investors and economists have been for, though, the sectors most likely to benefit include real estate, utilities and financials, companies that typically employ more debt to finance their operations. In addition, high-quality growth stocks that rely on borrowing to fuel their expansions could also benefit significantly.
Why real estate and financial stocks benefit the most
Lower interest rates provide a significant boost to capital-intensive businesses like real estate and asset management firms. These companies use a lot of debt to finance their operations, so when borrowing costs decline, profitability naturally increases.
Additionally, lower rates often lead to increased demand for housing and commercial properties, driving up rental income and asset values. That’s why two of the best-positioned TSX stocks in this environment are Brookfield (TSX: BN) and Canadian Apartment Properties REIT (TSX: CAR.UN).
Brookfield Corporation is a leading global investment firm that has long been one of the best long-term investments in Canada. However, it can especially thrive in environments with lower interest rates.
With investments in essential infrastructure assets, private equity, and real estate, Brookfield benefits from reduced borrowing costs, making capital-intensive projects more profitable.
Additionally, a lower-rate environment drives more investor capital into alternative assets, which Brookfield specializes in, positioning the company for significant growth as the economy stabilizes and rates decline.
Brookfield has a long history of acquiring undervalued assets and maximizing their value over time. Therefore, with a strong balance sheet and a diversified portfolio of real estate, infrastructure, and renewable energy assets, Brookfield is well-positioned to benefit from the economic tailwinds that lower rates provide.
Therefore, Brookfield stock could see significant upside as capital markets improve and asset valuations rise.
Canadian Apartment Properties REIT (CAPREIT) is one of Canada’s largest residential REITs; it’s another top stock that could benefit from lower interest rates.
Real estate is heavily impacted by financing costs, and lower interest rates make it cheaper for CAPREIT to acquire new properties and refinance existing debt. Additionally, with housing demand remaining strong across Canada, CAPREIT is well-positioned to grow rental income and expand its portfolio, offering investors both stability and long-term upside.
Plus, in addition to these economic tailwinds, CAPREIT has a strong track record of consistent growth and dividend payments, making it a top choice for income investors. In fact, it currently offers a yield of roughly 3.7%. Therefore, as borrowing costs decline, the REIT could accelerate its expansion plans, further boosting shareholder value.
