Buy High Visibility Cash Flows For The Rate Cut Cycle

Core Viewpoint - The upcoming cycle of interest rate cuts is expected to correct mispricing in securities, particularly benefiting those with high visibility and certainty of cash flows, while those with low certainty may remain mispriced [1][2]. Group 1: Discounting and Cash Flow Visibility - The article discusses the application of discounting math to both bonds and equities, highlighting that securities with high visibility of cash flows are better positioned as interest rates decrease [2]. - Bonds have perfect visibility of cash flows, allowing precise discounting calculations, while equities exhibit more complexity due to varying cash flow visibility [3][9]. - Value stocks, characterized by lower duration due to high earnings relative to price, should theoretically outperform growth stocks during rate hikes, but this has not been observed in practice [10][11]. Group 2: Mispricing Observations - Despite the expectation that growth stocks would suffer more during rate hikes due to their higher duration, they have outperformed value stocks, indicating a significant mispricing in the market [11][13]. - The observed phenomenon shows that value stocks with visible cash flows were more punished during interest rate increases, contrary to mathematical expectations [22]. - REITs and utilities, which have high cash flow visibility and shorter durations, were expected to be more resilient but also faced mispricing during the rate hike cycle [23][24]. Group 3: Future Expectations and Sector Performance - As interest rates are anticipated to decrease, sectors with high cash flow visibility, such as REITs and utilities, are expected to benefit significantly from the rate cuts [26][28]. - The long-duration sectors are projected to be the biggest beneficiaries of rate cuts, with specific subsectors like triple net, retail, and industrial REITs expected to outperform due to their long rental contracts [32]. - The current valuation and fundamental strength in these subsectors support the expectation of outperformance during the upcoming rate cut cycle [33].