Stock markets are closing in on all-time highs.
Meanwhile, the US Federal Reserve (US Fed) will likely reduce rates by the end of this month.
This combination may leave you wondering: Will the stock market keep rising as the rates drop, or is it too risky to venture into stocks as they peak?
Let’s break it down.
Why Interest Rates are Important for Stock Valuations
Mathematically, declining rates will raise the value of a stock as it reduces the discount rate on the future value of its earnings.
Sounds complicated?
Let’s take this one step at a time.
By discount rate, we are looking at the percentage that reduces the future value of earnings.
In layman’s terms, what the company makes today will be worth less tomorrow because of factors such as inflation.
How does this play out in real life?
When interest rates are high, investing in stocks becomes less attractive.
Simply put, if we can get better returns by depositing our money in the bank, why take the risk?
But when rates are low, we don’t get much by keeping our money in the bank.
In turn, a stock’s future earnings will look more valuable.
Thus, investors are willing to wait for their money to appreciate.
This phenomenon has occurred in the past: the S&P 500 shot up by 27% in 2021 after the US Fed cut rates in 2020.
Let’s not forget: when interest rates are low, companies can borrow at a cheaper rate too.
This additional capital will come in handy if the company wants to grow.
Yet, not all companies will benefit from lower interest rates.
Winners When Interest Rates are Falling
So what type of companies stand to benefit from falling interest rates?
1. Real estate investment trusts (REITs)
With lower interest rates, REITs will be able to re-finance their existing loans at cheaper rates and borrow money at a lower cost to buy new rental-generating assets.
Meanwhile, the cheaper financing cost allows the REITs to offer better yield spreads compared to bonds.
Take the example of CapitaLand Integrated Commercial Trust (SGX: C38U), or CICT, which makes regular and growing distributions to its unitholders.
CICT achieves these results through a combination of asset enhancement initiatives (AEI), capital recycling, and new acquisitions.
The REIT’s distributable income grew 12.4% year on year to S$412 million for the first half of 2025 (1H2025), while recording a rise in distribution per unit (DPU) by 3.5% to S$0.0562.
2. Growth Stocks
The reason why growth stocks will benefit when the US Fed lowers interest rates is because a significant portion of their value is derived from earnings projected far into the future.
One such company is Apple Inc. (NASDAQ: AAPL).
For the third quarter of its fiscal 2025, Apple announced quarterly revenue of US$94 billion, up close to 10% compared to a year ago.
The iPhone maker also announced diluted earnings per share of $1.57, 12% higher year on year.
Simply said, investors are banking on Apple growing its earnings in the future — and when this is discounted back at a lower rate, the value of its future cash flows are higher than before.
3. Dividend Stocks
Lower interest rates also make dividend yields look more attractive.
That is exactly what happened with Coca-Cola Company (NYSE: KO).
The company’s diluted earnings per share (EPS) increased by 57% to US$0.88 for 2025’s second quarter (2Q2025).
This increase can be attributed to the company reintroducing its famous Share a Coke campaign, which taps on the nostalgia factor by personalising bottles and cans to better connect with its customers.
Meanwhile, Coca-Cola Zero Sugar achieved double digits growth for the fourth consecutive quarter.
At US$68.25, shares are offering a dividend yield of close to 3% based on an annualised dividend payout of US$2.04 per share.
Who Could Have Problems When the Interest Rates Fall
We have talked about the types of companies that do well when the rates are down.
Now let’s talk about companies that might struggle when the rates fall.
1. Banks
Net interest margins will fall as banks cannot charge higher rates on loans, which makes banks less profitable.
This is the case of a major US multinational financial services company, Wells Fargo & Company (NYSE: WFC).
Due to lower interest rates and deposit mix changes, its 2Q2025 net interest income fell by US$215 million, or 2% lower compared to a year ago, to US$11.7 billion from a year ago.
2. Highly Cyclical Sectors
Sometimes, the reduction of rates can signal a deceleration of the economy.
This slowdown can be tough on highly-cyclical industries, such as automotive, construction, luxury, travel, and hospitality, retail, and metals and mining.
Why is that the case?
Highly cyclical sectors are sensitive to the economy.
Their products and services tend to be discretionary and subject to consumer spending.
One example is Caterpillar Inc. (NYSE: CAT), a world’s leading construction and mining equipment manufacturing company.
Weak price realisation led to its 2Q2025 revenue falling by 1% year on year to US$16.6 billion.
What Investors Should Do When the Market is High
There is one thing we need to remember when the market is high.
Just because rate cuts can help extend bull markets, it is not risk-free.
As an investor, we should:
1. Focus on quality companies
Don’t follow hot stocks blindly.
Instead, ask ourselves: Is the business resilient? What about its financials?
We can achieve this by looking for companies with strong brands, low debt, and consistent free cash flow.
2. Use dividends as a cushion
Just because your valuation model shows that a stock is undervalued, it does not mean that the stock market will recognise it immediately.
For such a situation, stocks that pay dividends serve as a cushion, rewarding us as we wait for the share price to increase.
Think of it as the appetiser before the main course.
Income will come in handy in periods of decline in the market.
Get Smart
Declining rates can spur increases even at all-time highs, but remember: not all stocks will respond in the same way.
It is all about selecting the right stocks.
As investors, we should identify businesses that can capitalise on lower rates.
Then, we build portfolios around companies that can work at any stage of the cycle.
That is how we create long-term wealth.
We’ve found 5 SGX-listed dividend stocks with strong track records in turbulent markets. If you want consistency in an uncertain world, start here.
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Disclaimer: Yoong Shin owns shares of Apple Inc.
