Interest rates were lowered for the first time this year in September, and more rate reductions are expected.
Lower rates should provide fuel for stocks, with some areas of the market likely to benefit more than others.
Here are three top exchange-traded funds (ETFs) for a declining interest rate environment.
1. Invesco S&P MidCap Momentum ETF
Growth stocks and ETFs are typically sensitive to interest rate changes, but that is especially true for midcap and small caps. Because these are smaller companies, they generally don’t have the cash to invest in their growth, so they need to borrow. And when rates are down, borrowing costs are lower, and that tends to spark more investment and growth.
The Invesco S&P MidCap Momentum ETF (NYSEARCA:XMMO) is one of the top midcap growth ETFs. It has an average annualized five-year return of 15.4%. This year it is up 8.7%.
It tracks the S&P Midcap 400 Momentum Index, which includes the 80 stocks within the S&P Midcap 400 Index with the highest momentum scores. Momentum scores are calculated by measuring the upward price movements of stocks within the index.
The 3 largest stocks in the fund are Comfort Systems (NYSE:FIX), Talen Energy (NASDAQ:TLN), and Curtiss-Wright (NYSE:CW).
2. First Trust Small Cap Growth AlphaDEX ETF
For the same reasons as midcap growth stocks, small cap growth equities tend to thrive with lower interest rates.
One of the most aggressive small cap growth ETFs is the First Trust Small Cap Growth AlphaDEX ETF (NASDAQ:FYC). This ETF tracks the Nasdaq AlphaDEX Small Cap Growth index, an enhanced index created that includes stocks from the Nasdaq US 700 Small Cap Growth Index that meet certain growth criteria.
The growth factors include 3-, 6- and 12- month price appreciation, sales to price, and one year sales growth. Stocks are ranked on their growth scores and the top 262 make the portfolio.
The top 3 holdings are Eos Energy (NASDAQ:EOSE), Planet Labs (NYSE:PL), and CommScope (NASDAQ:COMM).
The ETF has a five-year annualized return of 13.9%. It is up 16.2% year-to-date.
3. Invesco KBW Bank Index ETF
Banking stocks should also perform well in a lower rate environment. Typically, higher interest rates are good for banks, because they earn more interest income on loans. But if rates are too high, as they have been, it can have a negative effect because fewer businesses and individuals are taking out loans. Plus, banks have to pay higher interest rates for deposits to keep their customers in a competitive environment.
But rates could be ticking down to a sweet spot for banks, low enough to spark investment and loan activity, but still high enough to generate significant interest income.
The Invesco KBW Bank Index ETF (NASDAQ:KBWB) tracks the 25 or so largest U.S. banks. The top three holdings are Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), and JPMorgan Chase (NYSE:JPM).
This ETF is up 18.4% YTD and has a five-year average annualized return of 15.9%.
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