Top 5 ETFs and Stocks to Watch as the Fed Eyes Rate Cuts

For much of the past two years, U.S. markets have been dominated by a higher-for-longer rate regime. Growth stocks, particularly the tech-heavy Magnificent Seven, have thrived in this environment. Meanwhile, dividend-focused names, healthcare stocks, and smaller-cap companies have struggled to keep pace. Elevated borrowing costs and tighter liquidity have weighed on rate-sensitive corners of the market.

That dynamic may now be on the verge of shifting.

At last week’s Jackson Hole Economic Symposium, Federal Reserve Chair Jerome Powell struck one of his most dovish tones in recent memory. While Powell acknowledged that inflation risks remain, especially if expectations drift higher, he emphasized growing concerns around the labor market and downside risks to growth. 

Importantly, he stopped short of pre-committing to any specific action, but his remarks strongly hinted that the Fed is preparing to cut rates as early as September. Markets wasted no time in pricing this in, with traders pricing an 80% probability of a 25 basis-point cut at the next meeting.

If this new policy path materializes, it could set the stage for a rotation in leadership. Or at the very least, it could lift previously lagging corners of the market. Dividend-paying stocks, small caps, and other yield-oriented plays that lagged under high-rate conditions may finally find a bid again.

Here are five ETFs and stocks worth considering for investors looking to get ahead of this potential pivot.

XHB: Homebuilders Could See a Meaningful Trend Develop

One of the more rate-sensitive dividend plays on the market is the SPDR S&P Homebuilders ETF (NYSEARCA: XHB). Housing has been under pressure for the past two years due to elevated mortgage and construction rates, which suppressed affordability and slowed transaction activity. Yet, despite these headwinds, homebuilder stocks have held up relatively well, thanks to tight supply and strong demand fundamentals.

Housing could see a meaningful breakout, and trends could develop with the Fed potentially cutting rates. Lower mortgage rates would improve affordability and drive new demand, providing a tailwind for homebuilders. XHB, which holds prominent names like D.R. Horton, Lennar, and PulteGroup, would directly benefit from this trend.

XHB also offers a dividend yield, though modest, and provides exposure to an industry that tends to be highly cyclical and sensitive to interest rates. If rates move lower, the housing sector could become a key driver of economic growth again, making XHB an attractive way to play that recovery. From a technical perspective, it’s positioned favorably.

After Powell’s remarks on Friday, the XHB broke out of a two-week consolidation and finished the day up over 5%. Such a move and relative strength indicate that institutions could see the sector as a leading beneficiary of rate cuts.

Healthcare Sector: Potential Mean Reversion

Over the past three years, the Health Care Select Sector SPDR (NYSEARCA: XLV) has returned just 2.75%, dramatically lagging both the S&P 500 and leading growth sectors, like technology. The underperformance reflects investor preference for high-growth technology over defensive sectors in a higher-rate world.

However, the industry could stage a comeback with monetary policy potentially turning, and many healthcare names have been beaten up.

Thanks to its defensive characteristics, healthcare has historically been a strong performer during periods of slowing growth. Unlike cyclical sectors, demand for healthcare services remains stable regardless of the economic cycle. A lower-rate environment could spark renewed interest from income-oriented investors seeking stable, dividend-paying sectors.

What makes XLV particularly compelling is its composition. The ETF holds some of the largest and most stable healthcare companies in the United States, including Johnson & Johnson (NYSE: JNJ), Eli Lilly (NYSE: LLY),  Pfizer (NYSE: PFE), Merck (NYSE: MRK), and UnitedHealth Group (NYSE: UNH). These companies offer attractive dividend yields, strong balance sheets and fairly attractive forward earnings valuations.

With healthcare lagging badly over the past several years, XLV may be positioned for mean reversion. A shift in policy from higher-for-longer to gradual easing could catalyze dividend-paying healthcare stocks to bridge the gap against the overall market, especially if economic growth shows signs of deceleration.

The Tide Is Shifting for Small-Caps

Small caps have been one of the biggest victims of the higher-rate regime. The iShares Russell 2000 ETF (NYSEARCA: IWM), which tracks small-cap U.S. stocks, has returned just 7.29% over the past three years. The reason is simple: small caps tend to carry higher debt loads and are more sensitive to borrowing costs.

Elevated rates squeeze margins and limit access to capital, creating a drag on performance.

But the tide may be starting to turn. Over the past quarter, IWM has been up more than 15.5%, signaling renewed investor appetite for small-cap exposure. This rebound suggests that capital is beginning to rotate back into rate-sensitive market areas, anticipating easier financial conditions. While IWM’s dividend yield of 1.06% isn’t particularly high, its potential lies in relative performance.

A rate cut could significantly relieve small-cap companies by lowering financing costs and improving growth prospects. 

If the Fed does begin cutting rates, small caps could be among the biggest beneficiaries, and IWM provides broad exposure to that theme. Recent price action suggests that institutions are positioning in small caps. Not only have small caps outperformed in the short term, but IWM recently traded to levels not seen since the end of 2024.

$240 remains the all-important breakout level and inflection point on a higher timeframe. If the IWM can break above this zone in the coming weeks, it could confirm the small-cap outperforming thesis for the mid-term.

United Healthcare: Buffett’s Latest Purchase

UnitedHealth Group (NYSE: UNH) is a potential mean reversion opportunity among XLV's top holdings. If there’s one dividend name currently surrounded by controversy yet attracting the attention of some of the sharpest investors in the world, it’s UnitedHealth Group.

Shares have been in freefall this year, down nearly 50% from their 52-week high. However, sentiment is shifting thanks to Berkshire Hathaway’s latest 13F filing, which revealed that Warren Buffett had quietly accumulated a fresh stake. Berkshire ended Q2 with five million shares valued at roughly $1.6 billion.

Buffett’s timing is notable because UnitedHealth has been anything but a market darling. The company has been weighed down by negative headlines, making it a poster child for public frustration over soaring healthcare costs. 

In addition, the Justice Department is investigating Medicare billing practices, adding another layer of uncertainty. Earlier this year, UnitedHealth pulled its annual earnings outlook, only to release a new 2025 guide that fell well short of Wall Street expectations. 

And yet, this is precisely the type of setup that attracts Buffett. He’s known for stepping into high-quality businesses during their darkest hours, betting that the underlying fundamentals will outlast the temporary storm.

At a market cap of around $278 billion, UnitedHealth remains America’s largest private health insurer, a dominant player in a sector where scale and reach matter.

The 2.88% dividend yield for income-oriented investors adds another layer of appeal. If the market has overshot on pessimism, UnitedHealth could represent a classic contrarian opportunity, one where the combination of yield, scale, and eventual recovery creates significant upside. Lower rates might also benefit UNH by reducing borrowing costs, resulting in increased healthcare spending and demand for UNH’s insurance and healthcare services.

SCHD: Exposure to High Quality Dividend Stocks

For investors who want targeted exposure to high-quality dividend stocks, the Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD) is one of the most popular choices on the market. The ETF focuses on companies with a consistent record of paying and growing dividends while screening for financial strength and attractive valuations.

SCHD’s appeal lies in its quality tilt. Its portfolio’s top three holdings include names like PepsiCo (NASDAQ: PEP), Cisco (NASDAQ: CSCO), and Chevron (NYSE: CVX), companies with durable cash flows and shareholder-friendly policies. The ETF currently yields 3.65%, making it attractive in an environment where yields on Treasuries and money market funds are likely to decline if the Fed cuts rates.

SCHD is compelling because it has already built a reputation among dividend investors as a core long-term holding. As policy shifts and yields on traditionally safer assets fall, SCHD could attract significant inflows from investors seeking reliable equity income. Its combination of yield, quality, and diversification offers a straightforward way to position for a lower-rate world.

Significant Market Rotation Could Be Around the Corner

For several years, the higher-for-longer rate narrative has contributed to market leadership. Growth stocks soared, while dividend-oriented plays, healthcare, and small caps lagged. Powell’s dovish shift at Jackson Hole signals that this regime may end and that market breadth could improve.

If rate cuts happen in September, it could open the door for a major shift into previously underperforming market areas.

Dividend ETFs and rate-sensitive sectors that have underperformed could finally begin to outperform or slightly bridge the gap. From defensive plays like XLV and UNH, to cyclical rebound opportunities in IWM and XHB, and core dividend exposure through SCHD, there are multiple ways for investors to position portfolios ahead of a potential policy pivot.

While no outcome is guaranteed, the market’s reaction to Powell’s remarks underscores the importance of preparing for this shift. For investors seeking yield and potential outperformance, these five ETFs and stocks represent potential timely opportunities in a changing market environment.

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