How the Fed's Rate Cuts Could Boost Bonds, Silver, and Small Caps

Key Points

• Three asset classes should be watched by investors before the year is over, some of which have already attracted Wall Street attention. 
• Backed by fundamental trends and momentum, these are the places investors could consider investing before everyone hops on the train.
• Some of Wall Street's mega investors have already positioned themselves in these areas, and the catalyst is just around the corner.

Investors may be shaken up by the recent volatility in the stock market, and now more than ever, it is important to stick to fundamentals and attempt to understand how and where money will begin to shift in the next quarter or two. Ideally, investors can get on these trends before they take on momentum during the whole market shift, where a few asset classes come to mind.

The main catalyst is the Federal Reserve’s (the Fed) promise to cut interest rates this September 2024. As interest rates come lower, broader market forces will likely start to prefer a few areas of the market over others; these include bonds and commodities. Investors can take a riskier route and invest directly in basic materials stocks or gain safer exposure through an exchange-traded fund (ETF) such as the iShares Silver Trust for a commodities play.

For bonds, the process of buying into them is simplified as well, this time through Stanley Druckenmiller’s pick in the iShares 20+ Year Treasury Bond ETF as money begins to look for the potential best way to ride the bond upside. Last but not least, this is another Druckenmiller pick for small-cap stocks, which historically depend on and tend to benefit from low interest rate environments, so the iShares Russell 2000 ETF should be considered.

How Adding Bonds Can Energize Your Investment Portfolio

Bond prices are inversely correlated to their yields, and when the Fed's interest rate decision to cut comes in, lower bond yields will, in turn, bring higher bond prices. The iShares 20+ Year Treasury Bond ETF NASDAQ: TLT has been on a tear lately, rallying from roughly $90 a share in the past quarter to $100.6 last week, a run of nearly 12% when the S&P 500 retreated from highs.

Warren Buffett is reportedly holding more bonds than the Fed itself. He is also using part of Berkshire Hathaway Inc.'s NYSE: BRK.B cash pile to gain exposure to the potential upside in this asset class. Other than the Fed cuts, another catalyst is at play for bonds, which historically predicts a rally nearly every time.

This indicator is the yield curve (ten-year yields minus two-year yields), which has been negative for over a year and a half and has now returned to positive. Every time this happens, it signals a clearer economic picture for the coming years, building confidence in investors' decisions to invest in longer-maturity bonds like the ones in this ETF.

However, bonds are not the only ones benefiting from the yield curve and rate cuts. Here's why silver is a better bet than gold.

Gold Gains Attention, But Silver Is Poised for a Strong Rally

If there is one dollar-quoted commodity that has gained popularity recently, it is gold. As it reaches an all-time high and nations like China stockpile the precious metal, investors are surprised, not knowing whether to buy near the highs or leave it alone.

The answer is neither. More upside can be found in its distant cousin, silver. Historically, the iShares Silver Trust NYSEARCA: SLV and the SPDR Gold Shares NYSEARCA: GLD have run a correlation of over 87%, meaning that they should—in theory—move together most of the time.

This is not the case today, as gold trades at an all-time high while silver is trading at roughly 86% of its 52-week high. The divergence in relative strength between the two commodities creates an asymmetric opportunity for investors to take advantage of today, as silver offers a more attractive risk-reward profile than gold.

Currency valuations are driven significantly by interest rates, so lower rates could also weaken the dollar, which in turn increases the price of any dollar-quoted commodity (like gold and silver). Most of this has potentially been priced into gold’s price and not into silver’s.

Why Small Cap Stocks Are a Top Pick on Wall Street Right Now

Fundstrat's Tom Lee made a bold call for investors to gain exposure to small-cap stocks this quarter. He quotes that a buy signal is now flashing, a signal that has not been in the markets since 2009.

Lee wasn't the only one who figured out the potential upside in small caps; Stanley Druckenmiller added to this ETF after selling out of his NVIDIA Co. NASDAQ: NVDA position recently as well. The reason for looking into small caps is as fundamentally sound as any.

Smaller businesses depend heavily on available and flexible financing to grow and function, which is why lower interest rates have such a bullish effect on them. Investors could consider this dip a potential buying opportunity because the iShares Russell 2000 ETF NYSEARCA: IWM has sold off by over 10% from its 52-week high.

As these other asset classes gain momentum, Wall Street's view is as clear as ever on this common belief of outperformance coming from interest rate cuts and shifting credit markets, trends that investors can take advantage of before they are widely known.