- Ms. Yellen speaks and the market's initial reaction is negative.
- Price action in financials and technology tell the 'real" story.
- Financials, Technology, Consumer Discretionary, & Cyclicals to outperform.
- Bottom line: nothing has changed, long term investors need to stay the course.
Federal Reserve Chairwoman Janet Yellen spoke and investors made their feelings known in a hurry this past Wednesday.
It appears that many interpreted the Fed's statements as they will end their bond-buying program in the "fall", then wait six months after the bond-buying program ends before raising short-term interest rates. Apparently the masses then concluded that Yellen and the Fed would (not could) be raising interest rates by April 2015. Once again it seems the people that are "fed obsessed" wish to slice, dice and parse every word that is uttered by the Fed, and this time completely misinterpreted the message.
Perhaps another view into the Fed's announcement is warranted.
The "fall" season, often called "autumn", in the U.S. takes place from the September equinox, Sept. 22 to Dec. 21. During this time, the Fed will conduct two policy meetings, Oct. 28-29 and Dec. 16-17.
Now if the Fed continues on it 's path to reduce the bond-buying program at the present pace, that implies that the Fed will purchase $15 billion in bonds in October and then it will have to decide if they are going to end QE completely at the October 28-29 policy meeting or possibly vote to end it in two steps.
Make the usual $10 billion reduction at the October meeting and then the last $5 billion at the December meeting. Depending on the choice, the program would end in either November or January. So, I don't believe it was really that clear as to what Ms.Yellen meant when she said the "fall". Perhaps it was stated that way to be vague, after all, why would anyone paint themselves into a corner. Frankly speaking, I doubt the Fed has gotten that far in their planning, given the critical economic data that has to be gathered and then scrutinized before any decisions are made.
However, it sure seemed to many that in fact the "fall" was written on a stone tablet as October 1st, then they concluded that 6 months from that day rates would rise. In my view, that simply isn't the case at all.
In fact , the Official Federal Reserve policy statement says it will wait for a "considerable time," after the asset purchase program ends before considering to raise rates.
In her first official press conference later that afternoon, Ms. Yellen said the following when questioned about the timeframe.
"This is the kind of term it's hard to define, but, you know, it probably means something on the order of around six months or that type of thing. But you know it depends. What the statement is saying is it depends what conditions are like. We need to see where the labor market is. How close are we to our full employment goal ? That will be a complicated assessment,, not just based on a single statistic. And how rapidly are we moving toward it? Are we really close and moving fast? Or are we getting closer, but moving very slowly? … Inflation matters here, too. And our general principle tries to capture that notion. If we have a substantial shortfall in inflation, if inflation is running below our 2 percent objective, that is a very good reason to hold the funds rate at its present range for longer."
I will admit, it is possible the Fed could start to raise rates by April 2015. However, based on what was stated in the official statement and reiterated by Ms. Yellen, quite a bit would have to go exactly right for that to happen. My contention is that if in fact that happens, the economy would have shown even more improvement from now until that time and the increase might well be warranted.
So, after every word was parsed, the markets and a score of pundits made an assumption that all of this was bad news on the interest rate front. In my view, based on what I have read and heard from the Fed, it's quite the contrary.
And on day two the price action in the S & P seemed to agree. The market recouped the entire loss it suffered in the initial knee jerk reaction after the Fed announcement.
The financials took off like a rocket, as savvy investors now seem to understand what a rising interest rate environment will mean to their bottom line. Whether that rate increase comes in April or later in 2015, it is a sector that I selected last August as a prime beneficiary of the Feds reduction in asset purchases. As time went on and the economy showed signs of improvement,, I reiterated those same words in November indicating that the sector was a "buy", and as I took a look at my first view of 2014, financials were selected as one of the best places to be invested in the coming new year.
Here is the environment that I forecasted when the discussion turned to fed tapering as described in my Aug 21, 2013 instablog post :
" As this is played out I can see the following results as overall market reactions as the "End of the QE 'trade" unfolds":
First, a stronger dollar, which will translate to watch the action in commodities as I believe it will be "sloppy"..
Gold will sink , trading much lower than it is today. Stocks will re-correlate to this new environment. Contrary to some opinion, equities can do quite well once the markets "adjusts" to a more normalized interest rate environment. We can also expect increased volatility (elevated VIX levels). "
And it sure seems as that is how it is playing out. Increased volatility so far this year, commodities action sure has been sloppy, and now this week, a stronger dollar, gold sold off hard, giving back all of the gains from the 'Ukraine Fear" episode.
All of this happening while equities cope with the needed adjustments in this new environment, and in my view will continue to do so with strength being displayed in the financials and technology.. The evidence; (NYSE:JPM)(NYSE:BAC) and a host of regional bank names, all hit new highs this week.
On the technology front, (NASDAQ:MSFT) just broke out of a 13 yr. base to a new high . (NASDAQ:INTC) has broken out of a month long trading range and moved higher, "Old tech" isn't dead just yet , combine that with many other tech names that continue to outperform, and it all implies further gains for the overall sector.
A simple conclusion can then be drawn from this price action;
Continued strength in these two sectors bodes well for the overall market to grind higher. Long term investors need to simply stay the course, as absolutely nothing has changed.
I continue to believe the scenario I laid out back in August of 2013 will continue to play out over time and as such believe the financial, technology, consumer discretionary, and cyclical sectors will outperform.
(BAC), (NYSE:C), (JPM), are all large cap banks that are still undervalued at these levels, and can be bought on any pullback. (NYSE:GS), (NYSE:LAZ) are my two selections in the investment banking world, with Lazard Capital, being my top selection.
Old tech names like Microsoft, Intel, Cisco are acceptable candidates for those who have not participated in the market to date. In my view a perfect way to wade into the water as each have free cash flows in excess of 8% combined with balance sheets that are the envy of most corporations. Add on their dividend yields as an added incentive for ownership.
As the initial market reaction indicated, the message delivered in last Wednesday's Fed announcement was completely misinterpreted. I also will note that the entire asset reduction plan has already shown to be beneficial to the cyclicals such as (NYSE:CAT), (NYSE:PX) and others which have shown strength for the last 4-5 months.
Add the rebound we have also witnessed in the consumer discretionary sector as more evidence.
The Fed has been the focus of many. In my view they are simply "fed obsessed". The cries have been that the Fed "could never taper ", they were in fact caught "in a box". Of course, those cries were coupled with the idea that if and when the Fed did reduce asset purchases the markets would collapse.
Nothing could be further from the truth as we have now seen a 35% reduction in asset purchases and the S & P is 1% from yet another all time high.
Not only was the latest announcement misinterpreted , but in fact the entire QE program and the beneficiaries of the asset reduction plan now in place, has been totally misunderstood by many.
I believe it prudent to concentrate with the sectors I have mentioned here as they are in fact the beneficiaries of the new environment that investors find themselves in.
Best of luck to all !!
Disclosure: I am long C, BAC, PM, PX, AT, TGT, BBBY.