When Good News = Bad News
Steven is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Since 1994, stock market returns are flat if you remove the three days before the Federal Reserve announces interest-rate decisions. This stat was taken from Fool writer Morgan Housel, in his “100 Mind-Blowing Facts About the Economy.” It’s no surprise the market likes the idea of more Quantitative Easing (QE). It likes the idea so much, the market rallies off of headlines that imply only glimmers of hope. QE has dictated market direction since the bottom in 2009 when version 1.0 was introduced. The long term investor would argue QE has allowed business fundamentals to improve and the market has risen to reflect this improvement. Who’s right or wrong isn’t really important because it’s a chicken and the egg argument – endless in cycle.
What’s important is how investors are going to react when enough good economic news green-lights the Fed to begin the greatest unwind in policy history.
Jobs Are Bad!
On Friday, the U.S Bureau of Labor Statistics reported that 163,000 jobs were added to the economy in the month of July, beating the consensus of 100,000. The market rallied almost 2% on the news. Left-for-dead Hewlett-Packard (NYSE: HPQ) rallied over 4% on the day. Why a better employment report equates to an immediate perceptive improvement in their business remains to be seen.
It will be interesting to see if we get some follow through from Friday and continue to rally off the news. Although I’m not a market timer, I wouldn’t be surprised if headlines begin to talk down the prospect of QE because the economy might be improving more than expected. Since we are so headline driven, markets may respond accordingly.
Hold Your Horses
Ending QE doesn’t mean the Fed is going to formally raise rates anytime soon. While true, the end of Operation Twist will likely bring Treasury rates modestly higher, the Fed Funds Rate likely isn’t moving until late 2014 – because they told us so. The only way I could see otherwise is if we get some serious inflation creeping in, which isn’t currently a threat. Should this happen, stocks will be desirable because they outperform during bouts of sustained inflation. At first, stocks tend to underperform because rising input costs have only been incurred by the companies, pressuring their margins. However, all of this changes when inflation is passed on and then recycled in the form of top line growth.
In these situations, the dollar tends to fall, and if that happens, it would make sense buy American based multinationals that earn a significant portion overseas. Oil juggernaut ExxonMobil (NYSE: XOM) earns 68% of their revenues overseas, making them well positioned for this scenario.
If you’re wondering who else is going to benefit, look no further than Intel (NASDAQ: INTC). Chipzilla earned nearly 80% of its 2011 revenue from sources outside of North America. Not only does this company offer great value at current levels, it can also act as a hedge against sustained inflation.
Preparing for the Worst
When rates begin to rise, bond prices will fall. I like ProShares Short 20+ Year Treasury (NYSEMKT: TBF) as a way to capitalize on this future trend. It’s an ETF product that shorts the “long end” of the curve without using leverage. This eliminates beta slippage, making it a good candidate for long-term investors.
If ETFs aren’t your thing, consider Chares Schwab (NYSE: SCHW). They are continuing to build their well run business with net new account openings and have been growing assets under management. A big profit center for them has been turned off for the last three years. It relates to their money markets. These products invest in short-term fixed income, which have been unable to achieve yields higher than their fees. This has forced Chuck to waive fees, totaling over $100 million each quarter. Once rates begin to rise, fee waivers will be reduced, and profitability should improve nicely.
Take it or Leave it
In the long-term, ending QE is a great thing for investors. It would be a sign of confidence that the Fed thinks the economy can stand on its own. As investors, we have to look past the headlines and prepare our portfolio for likely events still off in the horizon. Ideally, we should do it before the market decides to fixate on them.
TopDownTrends owns shares of Intel & TBF. The Motley Fool owns shares of Intel and ExxonMobil. Motley Fool newsletter services recommend Charles Schwab and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.