Global retail investors are significantly increasing their exposure to equities following the Federal Reserve's (Fed) first interest rate cut in four years, according to new data from eToro. Riskier assets are gaining in favor of Forex (FX) market and cash, where a decline in investor interest is becoming more evident.

Retail Investors Flock to Stocks as Fed Begins Rate-Cutting Cycle

The eToro’s quarterly Retail Investor Beat survey, which polled 10,000 retail investors across 12 countries, revealed a marked shift towards stocks and away from cash assets in the third quarter of 2024. The proportion of investors holding locally listed stocks jumped from 49% to 54%, while those invested in international equities surged from 31% to 36%.

This reallocation comes on the heels of the Fed's decision last week to lower interest rates, signaling an end to the era of high-yield savings accounts. As a result, investors appear to be seeking higher returns in the stock market.

"With the Fed finally pulling the trigger on interest rate cuts, we are seeing the beginning of the end for bumper savings rates," said Sam North, an analyst at eToro. "This will inevitably lead to more people looking to the stock market to achieve a better return on their cash."

The trend towards equities was particularly pronounced among millennial investors, aged 29 to 43. This group saw a 16% quarter-over-quarter increase in local stock ownership and a 24% jump in foreign stock holdings. In contrast, Generation Z investors showed more modest increases, while the oldest investors, the so-called silent generation, reduced their stock exposure.

North attributed the millennial-led charge to their longer investment horizons and greater cash availability compared to younger investors. "This generation has the luxury of time on their side, allowing them to ride out market ups and downs in pursuit of long-term growth," he explained. “Gen Z is already fairly well invested, whilst the oldest cohort of investors is sensibly scaling back to safeguard their wealth.”

The report also showed which sectors of the increasingly popular stock market are attracting the most investor attention. While technology shares remained popular, with 44% of investors allocated to the sector, healthcare and energy also saw significant increases in investor interest.

As the Fed's rate-cutting cycle gets underway, these shifts in retail investor behavior could have significant implications for market dynamics in the coming months. With cash becoming less attractive and equities gaining favor, the stock market may see continued inflows from individual investors seeking higher returns in a lower interest rate environment.

Due to the growing popularity of stocks, eToro added over 1,000 UK shares to its offerings in July through its latest collaboration with the London Stock Exchange. This month, it has established a similar partnership with the German stock exchange, presenting investors with 290 local stocks

Why Rate Cuts Increase Stock Prices

Interest rate cuts by the Fed typically have a positive impact on stock prices for several reasons:

• Cheaper borrowing for businesses
• Increased consumer spending
• Relative attractiveness of stocks
• Discounted cash flow models
• Economic stimulus
• Market psychology

When interest rates are lowered, companies can borrow money at lower costs. This allows them to invest in growth initiatives, expand operations, or refinance existing debt at more favorable terms. These factors can lead to improved profitability and higher stock valuations.

Lower interest rates make borrowing more affordable for consumers as well. This can stimulate spending on big-ticket items like homes and cars, boosting economic activity and corporate earnings.

As interest rates decline, the yields on fixed-income investments like bonds and savings accounts become less attractive. This prompts investors to seek higher returns in the stock market, increasing demand for equities and driving up prices.

Many investors use discounted cash flow models to value stocks. Lower interest rates reduce the discount rate used in these models, making future earnings more valuable in today's terms and potentially increasing stock valuations.

“A lower interest rate environment is also good for listed businesses, meaning we can expect earnings to remain resilient or even grow, which further supports equity markets,” added North. “As a result, investors are likely to continue reallocating funds from cash to equities in search of higher returns."

Rate cuts are often implemented to stimulate economic growth. A stronger economy generally leads to higher corporate profits, which can translate into rising stock prices. What is more, the mere anticipation of rate cuts can boost investor confidence and risk appetite, leading to increased buying activity in the stock market.

It's important to note that while rate cuts often have a positive impact on stock prices, the relationship is not always straightforward. Other factors, such as economic conditions, geopolitical events, and company-specific news, can also influence stock market performance.