Interest Rates: A Tailwind for Investing in Durable Quality

The Federal Reserve is cutting rates again, firmly marking June 2024 as the peak this cycle. Historically, from 1984-2021, cutting cycles have been positive for equities broadly and quality equities in particular. These tend to outperform periods after peak rates, especially over longer horizons. Three years after rates peak, quality equities have historically been ahead of all equities by 26%.  

Equity Performance in Years After Peak Rates, 1984-2021​

Source: Blackrock Fundamental Equities, with data from the Board of Governors of the Federal Reserve System and Bloomberg, calculated from Aug. 31 1984- Dec 31, 2021. Returns are calculated from peak rates periods in 1984, 1989, 1995, 2000, 2006 and 2018. All Equities represented by the Russel 1000 Index. Quality is the top quintile of stocks as ranked in the Russel 1000 Index using a proprietary research screen that assesses companies on a 13 “quality” metrics. High and low beta (a measure of volatility relative to the broader market) are derived from the Blackrock Fundamental Equity Risk Model. Past performance is not indicative of current or future results. Indexes are unmanaged. It is not possible to invest directly in an index 

Why Would Rate Cuts be Such a Positive Driver of Returns?

The US economy is entering a late cycle environment, and the Fed is responding to weakening labor markets by cutting rates. These environments, when consumption is barely growing on an inflation adjusted basis, tend to lead to more uncertainty. Investors value quality, especially with durable characteristics, because it provides visibility of earnings in a potential storm.

As we touched on in our previous article, Quality During Times of Uncertainty, durable quality companies have highly recurring revenues that stretch out into the future. Idexx, that provides diagnostics for pets, has nearly 95% of its revenues recurring every year. Even cyclical firms like GE have nearly 70% of revenues recurring due to aftermarket servicing of jet engines. Such long-term earnings streams also get discounted more favorably as rates fall, helping quality firm valuations.

The Bottom Line

Although rate cuts are a clear catalyst and tailwind for quality stocks now, it is worth remembering that durable quality is about the very long run. The longer the horizon the more quality tends to outperform. A CFA study found that on any given one-year period from 2008 to September 2025, global quality stocks outperformed the global market only 60% of the time. If you extend the period to 10 years this rises to 100% of the time¹. Patience pays, especially, as we see now if you have a rate cutting tailwind.

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