How to Trade the Fed
Fed Chair Janet Yellen is widely expected to hike interest rates later today at a time when most investors have no clue what that means for their money.
Thankfully, we don’t have that problem.
Here’s what you need to know (and do).
Fed Chair Janet Yellen is expected to take the microphone a few hours after markets open Wednesday with a very simple two-part message:
- She (and, by implication, the Fed) is in control, and…
- The Fed is taking proactive action to ensure continued economic expansion.
Both are laughable.
Janet Yellen’s Fed lost control several years ago and they’ve been playing catch-up ever since. They’ve also been flying by the seat of their pants.
The growth that they’ve been trying to engineer hasn’t happened despite having spent trillions of dollars. Wage growth is still stagnant and millions of people who want to work have permanently left the work force. The wrong kind of inflation runs rampant while the “right kind” is non-existent, according to policy wonks.
The Bank of Japan lit out on its own, citing persistent deflation as justification of its bond-buying program to keep rates low last September. Then China’s central bank announced it would stop providing limitless cheap money last October, causing rates to surge 40 basis points. Both effectively did Yellen’s job for her when she refused to raise rates besides allowing a symbolic 25-basis point rate hike last December.
Now Trump’s fiscal policies are producing a change in sentiment and suddenly she’s on a mission to make sure President-elect Donald Trump’s policies are not overly inflationary??!!
In my best Dr. Evil voice… riiiiiiight.
The markets expect higher rates ahead because traders view rates as a measure of risk and return when the Fed and most investors think about them in terms of yield. That’s why bond prices have been declining and yields increasing since early October.
I expect Yellen to adopt a hawkish posture that alludes to the prospect of raising rates further and faster with the expectation that’s going to “cool” markets off. At the same time, I expect her to spend a good deal of time talking about how she’s going to take a “wait and see” approach when it comes to “the Donald’s” plans.
Either way, she’s totally reactionary.
If there’s a silver lining in all this, it’s that traders all over the world have been preparing for this moment. They’ve hedged nearly everything they can hedge.
You won’t see most of that because we’re talking about high finance – derivatives, synthetics, and structured products – but you will most definitely feel the effects of what they’re doing because the volatility associated with her announcement will be a fraction of what it’s been in the past. If we’re really lucky, the markets may even consider her commentary a non-event.
There are obviously no guarantees, which is why I want to do three things ahead of the Fed. We’ve been talking about them for some time now so they shouldn’t be a surprise, but more of a reminder:
- Make sure you’ve got your trailing stops in place. That’ll protect you and your money “just in case” a small rate hike induced squiggle turns into something more serious.
- Buy shares in the Rydex Inverse S&P 500 Strategy Fund (MUTF:RYURX) or its ETF equivalent ProShares Short S&P 500 (NYSEArca:SH). Studies show that having 2-5% in these contrarian plays will provide meaningful protection against the volatility that’s going to confuse most investors because they zig when everything else zags – meaning they’ll appreciate when the S&P 500 drops. If you’re options savvy, consider buying put options as an alternative. And;
- Get your money ready to buy using LowBall Orders. President-elect Trump has made it very clear that he’s going to do whatever it takes to “make America great again” and that tells me plenty of capital is headed into markets rather than away from them.
And if you’ve got bonds?
I’m getting asked that a lot as you might imagine.
Right now your duration – meaning how sensitive your bonds are to interest rates – should be between 3 and 5 years. Roughly speaking, that means your bonds will lose as much as 3-5% if rates rise for every 1% increase, or between 0.75% and 1.25% for a rate hike of 0.25%.
In the scheme of things, that’s just not something to panic about when we’re tracking companies like Raytheon Co. (NYSE:RTN), Becton, Dickinson & Co. (NYSE:BDX) and Altria Group Inc. (NYSE:MO), which have returned 269%, 145% and even 367%, and which show no signs of slowing down.
Buy low sell high is always the path to bigger profits…
…and no amount of interest rate jawboning can change that.