Separate Fed Fact from Fed Fiction ... Before it Costs YOU Money!

Wednesday, June 05, 2019
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Forgive me for being blunt. But there is a TON of “Fed Fiction” floating around out there right now.

Frankly, that worries me sick ... because listening to it could cost YOU money! So, I’m going to do my best to counter misguided Fed fiction with concrete Fed facts.

Let’s start with some recent history. You probably know the Federal Reserve has been raising interest rates since December 2015. The benchmark Federal Funds rate has climbed from a range of 0% to 0.25% back then to 2.25% to 2.5% now as a result of those moves.

But after the last hike in December 2018, the Fed began to get cold feet. Policymakers started wondering aloud if maybe they went too far given what was happening in the global economy and signaled they would put their rate-hiking cycle on pause.

Then earlier this week, one Fed speaker went a bit further. St. Louis Fed President James Bullard indicated in a speech Monday that the Fed might soon need to lower rates a bit.

Meanwhile, the interest-rate markets have started aggressively pricing in future Fed action. Yields on 2-year Treasury notes are among the most sensitive to future Fed rate levels, and they just plunged the most in a two-day span since 2008. That was during the last credit crisis.

Another interest-rate investment – Eurodollar futures – have been soaring in price. That’s a sign bond investors are betting real money ... LOTS of it ... on the idea the Fed will cut rates later in 2019, probably more than once.

Investment banks and research firms are piling on, too. A pair of Evercore ISI strategists just said the “Fed will reluctantly cut rates three times starting in September,” while JPMorgan Chase economists now said they expect a pair of 25-basis-point cuts in September and December.

So, that’s why the Fed is on the front pages again. Now, let’s talk about the Fed Fiction problem. 

The popular narrative on Wall Street is that Fed rate cuts are always bullish for risky assets (stocks, junk bonds, etc.) It’s a great story. Kind of like tales of the tooth fairy. The problem is that actual, you know, data and facts don’t agree.

Consider this: Since the late 1980s, there have been four major rate-cutting cycles that followed a series of Fed hikes. How many of those proved bullish for stocks? One. The 1994-'95 cycle.

All three other times, the Fed pivoted from hiking to cutting cycles. And sharp corrections, recessions and/or brutal bear markets followed.

Take a look at this chart. It shows the Dow Jones Industrial Average from 2007 through 2009. I’ve circled the time when the Fed first cut rates.

You can see stocks jumped that day, then rallied a bit further for a couple weeks. But that was all she wrote. The housing market soon collapsed, the economy rolled over, and stocks plunged roughly 57% from high to low.

What about the cycle before that? The early 2000s after the dot-com bubble burst? This chart shows the S&P 500 during that time frame, with the first Fed cut highlighted for easy reference.

You can see the S&P 500 rallied that day, then gained a few dozen points in the ensuing weeks. But that was about it. Stocks resumed their sickening slide, with the S&P ultimately losing 50% from high to low. The Nasdaq Composite plunged roughly 80%.

The downturn at the beginning of the 1990s (in the wake of Fed cuts then) wasn’t as severe. But markets did struggle for some time.

The only exception, again, was in the mid-1990s – and that was at a completely different point in the economic and market cycles. The economy had only been growing for a few years and the bull market was still relatively young.

Things are completely different today given that we’re close to the longest economic expansion ever and the bull market began all the way back in 2009.

Bottom line: IF we’re on the cusp of another major pivot in Fed policy, modern history suggests there’s a much greater chance it’ll be followed by serious trouble rather than a rocket ride rally.

And that makes sense, when you think about it. After all, the only reason the Fed would cut is that it thinks the economy is weakening, investor sentiment is souring, and recession risk is rising.

Do those catalysts sound bullish to you?

I don’t know if the Fed Fiction peddlers are deliberately lying, ignorant of history, intellectually lazy or something else. What I do know is that you should be skeptical of their claims, and instead take a reality-based approach when it comes to reacting to possible Fed action.

In practical terms, that means ...

1. Avoiding overhyped, over-loved, overvalued stocks in sectors like technology. Take the semiconductor names. I warned a month ago that they were behaving like they did in 1999; Now, they just collapsed 15%-plus in the blink of an eye.

Or how about the once-popular “FAANG” stocks, the ones I warned last August were headed for major trouble? They’re now suffering some of their worst declines in years amid fear of slowing growth and potential government antitrust or privacy-related actions. Facebook (FB, Rated “C+”) has tumbled 15% in the past year, while Google (GOOGL, Rated “B”) has dropped 10%.

2. Continuing to focus on “Safe Money” sectors and stocks. These companies offer juicier dividend yields, lower volatility, and generally more attractive Weiss Ratings. Plus, many operate in recession-resistant businesses. That makes them attractive if I’m right that a sharp economic slump is headed our way by next year.

After all, we’re all still going to eat, drink, and turn the lights on even in a downturn. Sales and earnings will therefore hold up better for these firms than it will for companies in the financial, transportation, technology, retail, and other “growthier” sectors.

3. Raising cash, remaining skeptical, and playing defense overall. This market has changed in many ways since the blow-off high in stocks back in January 2018. Ever since then, credit risk spreads have risen ... volatility has climbed ... the yield curve has collapsed ... successive stock market rallies have lacked broad participation ... and defensive sectors have outperformed offensive ones.

That’s exactly what I’ve seen first-hand before when the big, broad trend is turning. It’s why I’ve been urging you to carry more cash and play defense in your portfolio for almost a year and a half now ... and why that advice still holds true today!

Until next time,

Mike Larson

P.S. If you want to learn more about the Fed’s policy outlook ... and get some specific investing ideas to help you profit in these turbulent times ... join me at the MoneyShow Seattle next weekend. It runs June 15-16 at the Hyatt Regency Seattle, and I’d love to see you there.

You can get my complete line up of events, and register to attend for free, using this link. And even if you can’t make it, some of my events will be livestreamed online. That link has more information on how to get set up for that, too.

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