Savvy Investors’ Rate Cut Portfolio: Bonds, Small Caps, Energy

Most of the market attention remains with the technology sector today, where all of 2024 has been centered around every stock related to artificial intelligence, particularly those in the chip and semiconductor space. When reading this, most investors probably thought of NVIDIA Co. (NASDAQ: NVDA) and other names in that space, but that wave could soon be over.

The chip king has sold off over 20% in the past month, even after a recent earnings rally, leaving some in the market wondering where all this capital is headed. According to the CME’s FedWatch tool, the answer may lie with what the Federal Reserve (the Fed) is looking to do next, which involves cutting interest rates by September 2024. This is a big deal for everyone because rates tend to drive the whole market.

Those looking to position their portfolios in the best mix possible could look into the three main areas deemed ‘rate sensitive’ by fundamental reasoning and historical behavior. These three areas are government bonds, found in the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT), smaller companies that rely on accommodating financing rates in the iShares Russell 2000 ETF (NYSEARCA: IWM), and lastly the energy sector held in the Energy Sector Select Sector SPDR Fund (NYSEARCA: XLE).

The Bond ETF Leads the Charge in Interest Rate Rotation

Not many investors know the relationship between the Fed and bond yields in the treasury. To save time explaining the economics and fundamentals behind it, investors can say that it is inversely related to how the Fed feels.

When Jerome Powell expressed that he felt more comfortable with the Fed’s progress in controlling inflation, suggesting that interest rate cuts were on the horizon again, the bond ETF surged by nearly 1% in a single day.

Why? Cutting interest rates also reduces bond yields; when bond yields go lower, their prices move higher as an inverse. So, whenever investors see the Fed making a statement suggesting interest rate cuts, this bond ETF will move first.

Considering that its price today shows investors a decline of 11% on the year and over 30% in five years (to show a complete business cycle), investors can somewhat assume that the bottom could be coming soon, which will, of course, be set by the Fed’s decision to cut interest rates.

One confirmation that investors can take outside the fundamentals is the fact that Stanley Druckenmiller – the guy who traded shoulder to shoulder with George Soros – recently sold out of NVIDIA to redeploy his capital into the bond ETF alongside small-cap stocks within the Russell 2000 ETF as well, so that’s something.

Cheaper Financing Could Propel Small Cap Stocks in Interest Rate Rotation

The filter to follow here would ideally be any company with a relatively small capitalization (typically defined below $2 billion) and has over 75% debt as a function of total capital to make cheaper interest rates key to financing future operations at this leverage level.

To make the job quicker, investors can look into the Russell 2000 ETF like Druckenmiller did. But for those who need a hunt and are okay with the increased risk of owning individual stocks rather than a diversified and balanced ETF, there are other stocks that could make it to a watchlist.

One of those stocks is Denny’s Co. (NASDAQ: DENN); now that the stock trades near a 10x price to free cash flow multiple, analysts at Benchmark have valued the company at $15 a share, daring the stock to rally by roughly 120% from where it trades today.

Another stock on this list is Murphy Oil Co. (NYSE: MUR), which investors can follow after Warren Buffett finished his nine-day buying streak of Occidental Petroleum Co. (NYSE: OXY) to express his bullish view on the energy sector today.

Those at Mizuho placed a $59 a share price target on that stock, daring it to rally by 44% from today’s prices. Speaking of the energy sector.

Rate Cuts Could Trigger a New Commodity Cycle for Energy

There’s a reason Buffett chose oil, and it’s because when interest rates get cut. Money becomes cheaper, and businesses and consumers all around the globe will start to increase their transactional activities. For better or for worse, most of this activity relies on oil.

This new demand could prove Goldman Sachs analysts, who forecasted oil prices to reach a potential high of up to $100 a barrel this year. So far, Buffett has endorsed this view by allocating Occidental stock.

Investors can join the trend by choosing the energy ETF, in this case, given that oil and gas companies could lead the way higher.

Not only will the Fed be key here, but also trends in the ISM manufacturing PMI index, which show the oil industry as one of the few readings with a four-consecutive-month trend of expansionary activity.

Generac Holdings Stock: Mixed Signals Leave Investors Uncertain

Generac Holdings Inc. (NYSE: GNRC) has long been synonymous with backup power generation, holding a commanding presence in a market driven by the need for energyreliability. However, recent developments have created a complex narrative, leaving investors to decipher a mixture of positive and concerning signals. While institutional investors seem to be betting on the company’s long-term potential, insider selling and a divided analyst community add a layer of uncertainty. Generac’s ambitious move into the rapidly evolving energy storage sector further complicates this intricate picture.

Institutional Appetite for Generac Remains Strong

Despite some headwinds, Generac has attracted significant attention from institutional investors. Generac’s ownership data reveals that over the past year, numerous institutions have shown their confidence in the company by either initiating new positions or increasing their existing stakes in Generac.

This unwavering interest suggests a belief in the company’s ability to generate long-term value, particularly as the demand for energy resilience solutions continues to rise. Several factors likely underpin this positive sentiment. Generac holds a dominant position in the backup power generation market, a sector expected to benefit from aging grid infrastructure and the increasing frequency of extreme weather events, both of which threaten power disruptions.

Energy Storage: Generac’s Strategic Leap into a New Frontier

Generac’s acquisition of PowerPlay Battery Energy Storage Systems is a significant stride toward establishing a strong presence in the rapidly growing energy storage market. This strategic decision signifies the company’s ambition to evolve beyond its traditional stronghold of backup generators and position itself as a comprehensive energy solutions provider. By integrating PowerPlay’s technology and expertise, Generac can tap into new revenue streams and cater to a broader customer base, including those actively seeking greater control over their energy consumption and resilience.

The potential of this acquisition is substantial. The energy storage market is projected to experience exponential growth in the coming years, driven by factors such as the increasing adoption of renewable energy sources, the need for grid stabilization, and a growing desire among consumers and businesses for energy independence.

However, the path to success in the energy storage sector has obstacles. Generac will face intense competition from established players and emerging startups, all vying for dominance in this lucrative market. Successfully integrating PowerPlay’s operations and technology into Generac’s existing infrastructure will require seamless execution and a deep understanding of this evolving industry.

Analyst Perspectives on Generac

Despite the excitement surrounding the company’s move into energy storage, Generac’s analyst community remains divided on the company’s near-term prospects. This divergence of opinions is evident in the range of ratings assigned to Generac’s stock, from bullish “buy” recommendations to more cautious “hold” and even some bearish “sell” ratings. This lack of consensus is reflected in the target prices set by these analysts, which vary significantly.

Several factors contribute to this divided outlook. While showing modest revenue growth, Generac’s earnings reports have also revealed margin pressure, raising concerns about Generac’s ability to maintain profitability while pursuing its growth strategy. Additionally, macroeconomic factors, such as inflation and potential recessionary pressures, have led some analysts to adopt a more cautious stance.

Further complicating the picture for investors is the recent trend of insider selling. Over the past year, several high-ranking executives, including CEO Aaron Jagdfeld, have sold considerable amounts of stock. Data reveals a pattern of consistent selling by Jagdfeld, who has sold 5,000 shares every month since January 2024, totaling 30,000 shares in the first half of the year. Adding to this, another insider, Patrick John Forsythe, sold a substantial 65,855 shares in May 2024 at an average price of $145.80, culminating in a transaction exceeding $9.6 million.

While it is important to note that insider selling is not always a definitive indicator of a company’s future performance and can be driven by personal financial decisions, the consistency, and volume of these transactions, particularly in light of other mixed signals, warrant scrutiny from investors.

Generac’s Fluctuating Stock Performance

Generac’s stock is currently trading around $136 and has experienced its share of volatility, reflecting the uncertainty surrounding the company’s future trajectory. The stock has fluctuated within a 52-week range of $79.86 to $156.95, illustrating its sensitivity to market sentiment, analyst pronouncements, and shifts in the broader economic landscape. Despite a respectable 3.03% gain since the start of the year, Generac’s stock has declined by 10.71% over the past year.

This volatility underscores the inherent risks and rewards associated with investing in a company undergoing a pivotal transformation. While promising, Generac’s strategic expansion into energy storage carries uncertainty. Additionally, the cyclical nature of the energy industry and potential economic headwinds contribute to the unpredictable nature of Generac’s stock price.

A Balanced Approach is Prudent for Generac

Generac Holdings presents a compelling investment case for those seeking exposure to the growing energy resilience market. Its dominant position in backup power generation, coupled with its strategic push into energy storage, positions it to capitalize on trends shaping the future of energy. This potential is further underscored by strong institutional investor interest and a healthy projected earnings growth rate of 30.89% for the coming year. However, investors must carefully weigh these opportunities against the company’s inherent risks and uncertainties.

While open to interpretation, persistent insider selling raises valid concerns that should not be ignored. Additionally, divided analyst sentiment and the inherent volatility of Generac’s stock price highlight the importance of conducting thorough due diligence and aligning investment decisions with individual risk tolerances and investment horizons. A measured and informed approach, considering the potential upsides and potential downsides, is essential before you decide to navigate the complexities of Generac Holdings as an investment opportunity.

Analysts and Earnings Propel the S&P 500’s Continuous Growth

The S&P 500 (NYSEARCA: SPY) can continue to climb its wall of worry because its foundation is built on earnings growth. The bricks are made from FOMC and inflation news bites, which sustain a low level but subsiding fear. The bricks may grow heavy enough to keep the market from rising more, or the wall may become top-heavy and lead to a crash, but that hasn’t happened yet. Because the June PCE price index aligns with an outlook for a soft landing and an eventual interest rate cut, the wall could grow until some other reason to worry emerges. The target today is the S&P 500 at 6,100.

Inflation and the FOMC: Analysts and Revisions Drive the S&P

The June PCE price index was a Goldilocks report, not too hot to inflame fear of inflation and not too cold to raise doubt about economic health. The takeaway is that the “new normal” put in place three years ago is still in place today and that inflation is cooling. In this environment, economic growth and earnings health are spotty but present and sufficient to offset weakness. This means that the S&P 500 returned to earnings growth last year; growth is accelerating in 2024 and is expected to accelerate in 2025.

Inflation is expected to continue cooling. The CME’s FedWatch Tool shows the market pricing in the first interest rate cut will come by November and that two will be possible by the year’s end. That will mark a real economic shift that will sustain, if not improve, the outlook for earnings. The risk with the earnings outlook is that the market is front-running. It will start looking to 2026 as soon as the fall, which could alter the outlook if earnings growth is forecasted to stagnate. Until then, analysts are raising their estimates for earnings and stock prices and leading the S&P 500 higher.

Big Tech and Mag Seven Lead a Concentrated Market

Big Tech and Magnificent Seven have led the market for the last few years and will continue to do so in the second half. Analysts are supportive and continue raising their estimates for these stocks because of their position in the AI industry.

Wedbush sees the S&P 500 rising another 15%. In their view, index growth will accelerate as expanding use cases for AI broadens the market for today’s AI leaders and leads to a broader rally in tech. The analysts’ top two choices are NVIDIA (NASDAQ: NVDA) and Microsoft (NASDAQ: MSFT), which have emerged as the leaders in the enterprise AI industry, but most Mag Seven names are included in their forecast. Others, like Apple (NASDAQ: AAPL), are well-positioned to monetize AI while using it to widen margins. Productivity and automation will emerge as central themes.

NVIDIA, Microsoft, and Apple are the three largest components of the S&P 500, comprising 22% of the index, and their analysts are raising targets. Morgan Stanley is the latest to update on NVIDIA, and it has raised its estimates for earnings and share prices based on channel checks in Asia.

According to Morgan Stanley (NYSE: MS), demand for NVIDIA’s Hopper line remains robust and will sustain revenue and earnings power during the transition to Blackwell. That will be next year. Morgan Stanley’s new target is $144, a 20% gain from today’s level, and it is not the highest target issued. That belongs to Rosenblatt and is another 35% of upside. Likewise, Microsoft analysts are supporting its market and leading to the high end of their range, a 20% upside for its stock. Apple is forecasted to rise nearly 30% at the high end of its target range.

The S&P 500 Has Room to Run

The S&P 500 trades near a critical resistance point but will likely move higher soon. The rally is technically strong, the chart shows a budding buy signal, and earnings season is near. Microsoft and many Mag Seven names report mid-to-late July, while NVIDIA and many semiconductor stocks report later in August, so index results could create a new high and sustain a rally over the summer. Assuming the market sets a new high, the rally could last through year’s end. The technical target is 6,100 but may be surpassed because Wedbush’s target is closer to 6,250.