Since there is no determination of when QE will end, investors should have a playbook in place for whatever scenario besets them.
Of course, there is no way to predict what will happen in the future but given the enormous question mark around whether the U.S. Federal Reserve will continue QE, investors should at least consider their current investments and a potential market response if QE were to taper or discontinue. In other words, will interest rates spike up if the accommodative Federal Reserve stops QE at its current rate of $85 billion a month. Stimulus is clearly correlated with the overall market recovery in the United States and at its end, stocks will not respond uniformly.
Whether there is domestic growth or not, companies need to find a way to respond. Investors should be looking for stocks tied to companies that are nimble and have a history of earning in high interest rate environments. Failure to adapt to the changing economy and U.S. policies will plague most businesses when rates increase. Given the current fiscal and monetary policy environment, it is important to manage risk and find organic growth.
These measures lead to healthcare (XLV), industrial (XLI) and the U.S. Treasuries (TLT). Briefly, healthcare costs more than nearly any other cost have reliably become more expensive over the past 20 years, despite the Affordable Care Act there is no reason to think this trend reverses. Additionally, the fact that global and domestic prices continue to increase will partially offset spending concerns resulting from a rate increase. This rate increase would come on the heels of confidence from the Federal Reserve and Treasury in a healthy economy so it will be important not to forsake economic improvement for rate risk.
When prices increase earnings will increase; this fact supports industrials as consistently as any other sector. Finally, an appropriate level of risk includes the likelihood that the Fed continues to buy bonds and in the short term U.S. Treasuries will rise as yields fall. Investors might also realize that there are global threats that are of more immediate concern than the Fed exit and return to Treasuries as a relative safe haven. These factors will continue to pressure yields downward in the short term.
Two companies that will withstand the macroeconomic threats of a Fed exit and global growth concerns are UnitedHealth Group (UNH) and General Electric (GE). Combining the exposure of these two companies with a position in U.S. Treasuries could weather the uncertainty surrounding policies and global growth. The Treasury play is a trade and once 10-year yields return to the area around 1.65% should be sold. If interest rates Increase earlier than expected, a position in U.S. Treasuries will suffer, if interest rates continue to stay low after reaching 1.65% the downside risk would outweigh holding the position. General Electric and UnitedHealth Group are able to weather a sudden interest rate spike as well as a pullback in consumer spending due to any rate increase and are therefore good investments.
UnitedHealth Group and General Electric are great stocks choices in this environment because they are well managed and have access to sustainable demand in healthcare and they are prepared to continue to grow. Moreover, when these companies faced what many fear may happen to the 10-year soon back in 2006 when 10-year yields were over 5% GE shares were over $35. These are quality investments over the long term and investors can be confident that management, which has starred in recoveries since the financial crisis, can continue to support their growth. Over the past two years both companies shown below reflect the strength the Dow (DIA) has shown over the same period
Investors are still expecting QE, but concern over its end is growing. Once people stop expecting QE and become more concerned with the its ill-effects, like dollar devaluation and inflation, markets may begin to price in the Fed exit. This process will become more violent the deeper the government involvement becomes. Because of the increased burden the government is taking on markets have improved, but that is no guarantee that markets will continue to view QE as bullish news. The short term will supply upward pressure on prices, which will continue to support corporate earnings so stimulus should still be considered positive. However, care should be taken and it seems that Bernanke and his likely successor Janet Yellen will be reasonable with regard to this sensitive and unprecedented effort to support the U.S. economy.
Should interest rates increase, it will be a result of confidence in the economy and companies like these will welcome an end to stimulus if it means a healthy economy. UnitedHealth Group and General Electric each stand to continue to benefit from the stimulus-induced growth in the United States. These are two Dow components that can lead investors through QE and in a post-QE market. Investors should prepare for a market pullback because no market likes interest rate hikes, however sellers should prepare for the potential of being left behind these strong sectors and earnings growth at these two innovative companies.
Additional disclosure: I am not a professional advisor; my interpretations of the market are independent and should not be construed as investment advice