How to Handle Today’s “Rate Increase” Wildcard

Keith Fitz-Gerald Mar 11, 2015
18 

Yesterday capped a miserable three-day streak for U.S. markets on fears that the Fed may accelerate a possible interest rate hike, with the Dow, S&P 500, and NASDAQ shedding 1.09%, 1.79%, and 1.38% respectively.

Bring it on!

I’ve pointed out repeatedly since the Financial Crisis began that the “good is bad” meme followed by traders – which triggers market dips with every piece of significant good news thanks to paranoia the Fed will seize on it to raise rates – only creates buying opportunities for investors with the right tactics.

Today, that could be you.

Yesterday’s collapse creates three massive opportunities. I’m going to explain to you exactly what they are, why they exist, and most importantly why they’re being overlooked by insiders and mainstream investors alike.

Here’s what they’re all missing – and your opportunity.

The Stock Market’s Addiction

Make no bones about it, three successive Fed Chairman – Greenspan, Bernanke, and Yellen – have created a situation that’s allowed the markets to become addicted to cheap money the way a drug addict is addicted to his next fix.

Rather than seek a way out, they’ve facilitated an “all-gain no pain” rally based on tens of billions of dollars a month in stimulus and cheap money.

It’s been so powerful that it’s done exactly what they wanted and created a reality distortion vortex that’s caused millions of investors to dismiss bigger structural issues while allowing politicians on both side of the aisle to play a trillion dollar version of “Three-Card Monty.”

Unfortunately, I think it’s going to wind up more like “whack-a-mole.” You and I both know there will eventually be hell to pay. There always is. Just not tomorrow.

But here’s the thing: Wall Street would have you believe that a return to “normal rates” via a hike of any kind will lead to a massive market correction, an assumption I’ve always found really interesting.

History’s Verdict on Raising Rates

The historical precedent behind the effects of rate hikes on the stock market is much more nuanced than Wall Street lets on. In fact, the most recent and pertinent examples we have point to exactly the opposite thing happening – rate hikes causing rallies in their immediate aftermath.

Flash back to early 1980. A sense of economic malaise in the country turned to downright panic as inflation soared… yet the stock market was in the middle of an impressive bull run, showing strength that was widely out of step with almost every other economic indicator (much like today).

Then, in the spring of 1980, Fed Chairman Paul Volcker drew up experimental designs for a rate hike on a scale that would be unthinkable to Janet Yellen today. Volcker began a rate hike that would see rates climb to 19.03%… and stocks rallied through December.

SP 500

In mid-1983, the Fed decided to increase rates again in pursuit of an even more ambitious 11.44% target over the 8.50% it had already achieved. The result? The S&P 500 surged immediately, and it was still up 6.1% twelve months later compared to its pre-rate hike levels.

SP 500 2

I could cite more examples (the Fed’s $8.4 billion in fiscal tightening in 1987, the doubling of rates just before the stock market boom of the late ’90’s) but I think you get the idea.

Rate increases can actually be bullish.

In fact, if you look at the Fed Fund Rates dating all the way back to December 1, 1971, you can see that quite clearly.

Fed Funds Rate Small

Click to Enlarge

According to my colleague Sid Riggs, Director of Research and Performance Measurement, the markets actually went up, gaining an average of 13.47% during six of the last seven periods where the Fed raised rates. The only time the S&P 500 didn’t rise alongside rising rates was all the way back in 1970 when the Fed Funds Rate increased from 3.71% to 12.92%. I hardly think the Fed has the gall to jack rates by that much today.

For all of the power that unnatural stimulus has to juice the markets artificially, traders seem to have forgotten that getting the financial house in order is really the great hope here.

That means panic selling is an opportunity to buy.

I see three great ways to play the last gasps of Fed stimulus – and the eventual return to normal rates.

Three Stocks to Hedge the “Rate Increase” Wildcard

If markets oblige Wall Street’s expectations – but defy history thanks to the special circumstances of the most severe stimulus addiction I’ve seen in my investing lifetime – the swoon will be a sharp one, and you’ll need to be ready.

The best choices will be our “must haves.”

We’ve talked about these at length many times. These are the companies that supply services and products that are indispensable to humanity, and thus are recession-resistant, even immune.

Here are three to get you started.

Becton, Dickinson and Co. (NYSE:BDX) develops, manufactures, and sells a wide array of medical supplies and devices, instrument systems, diagnostic products and lab equipment. The majority of its products are single-use only, meaning the company benefits from re-orders on a consistent basis. It’s perfectly positioned behind our Demographics Trend, as the aging global population will create a demand for BDX’s health care services that is larger than ever. It offers a dividend yield of 1.70%, which is more than reasonable considering the ultra-low level of risk the stock carries.

American Water Works Company Inc. (NYSE:AWK) provides water and wastewater services to residential, commercial, industrial, and public consumers in both the United States and Canada. Because everyone relies on running water, AWK makes a perfect “must have” example – and like BDX, its services will only grow in demand as the world’s population continues to grow exponentially (the Demographics Trend at work again.) Its dividend yield is currently at 2.40%.

ABB Ltd. (NYSE:ABB) is a global leader in power and information technologies. Because of its role in almost every stage of the development, construction, and implementation of projects like smart grid technologies, power grids, and improvements of operations at chemical plants, ABB also provides services that humanity can’t do without. It offers a healthy yield of 2.80%.

In closing, I know it’s tough not to get wrapped up in the moment, especially when markets are getting carried out feet first like they did Tuesday. But try your best.

The point at which the markets reach maximum despondency is almost always the perfect time to buy.

I’ll be back Friday with a look at several additional recommendations related to Human Augmentation that are tearing it up.

Until then,

Keith

18 Responses to How to Handle Today’s “Rate Increase” Wildcard

  1. bob says:

    Interest rates rise as the economy improves so there must be a direct relationship between interest rates and stock prices in the long run. The only question which has to be asked is whether the extraordinarily low rates have had the effect of disturbing this relationship.
    Have the low rates caused the market to become rate return sensitive rather than growth sensitive, in other words as stocks became the highest return available did the separation between stocks and bonds become blurred? Did investors forget the difference between lending money and becoming an investor in the future of a company?
    It is likely that if that did happen there will be a new relationship for a period of correction followed by the return to the normal direct relationship.

    • Keith says:

      Hello Bob.

      You’ve made some terrific observations here. My sense is that the nature of debt has changed so there is indeed a serious separation. Interestingly, though, it’s oriented around the return of capital rather than the return on capital.

      I’ll explain more in an upcoming column.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  2. Dom Brunone says:

    Keith- Makes great sense, and I know its a Swiss-based company, but I wonder about ABB in light of currency issues and slow global macro-growth. It is down 25% from its peak last January. If 2014 didn’t work, what catalysts do you see in 2015 that will differ?

    • Keith says:

      Thanks for asking Dom. Frankly, I expected the company to move sharply higher in 2014 but the markets had other ideas. The contract flow remains good, management continues to realign itself and the need for electricity is not going away any time soon. Ergo, the original assumptions remain intact which means that it’s just as valuable a buy today as it was then albeit one that seemingly wants to test our patience.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  3. Kate says:

    Thanks, Keith. I appreciate your sane and expert approach to the markets. Especially today–I had a hard time sleeping last night. I don’t sell at moments like these, but I tend to hold back and miss bargains.

    • Keith says:

      You are welcome, Kate.

      No doubt days like yesterday are tough. Emotions run high and that’s not easy to dismiss especially when the recovery our government claims is happening still leaves so much to be desired for so many.

      But stick to your guns. Buy low and sell high is always the path to higher returns.

      I’ll do the best I can to help.

      Thanks for being part of the Total Wealth Family and best regards, Keith 🙂

  4. John Willis says:

    Keith, I am looking for a system that would provide consistent returns. Do you know of a way that I could accomplish this? I have always paid particular attention to Bill Patalon Private Briefing. Thank you, John Willis….

    • Keith says:

      Hello John.

      My colleague Bill Patalon is a very intelligent guy and has a keen sense for the markets. So you’re in good hands there.

      As for the notion of a system, I’m always leery when that word comes up. They have a nasty habit of breaking when you least expect it. “Approaches” on the other hand are flexible if you have the right guidelines.

      It may seem like I am splitting hairs here but there’s a reason.

      History shows that the most successful approaches are oriented around the combination of value and momentum combined with a good dose of risk management. Soros, Buffett, Templeton, Rogers…the most successful investors of our time all use shade of the same discipline. It’s their tactics that vary.

      And that’s a very personal decision based on your risk tolerance. For example, I may prefer to trade volatility while you may prefer options or ETFs. Other investors may simply confine their choices to stocks and bonds.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  5. Charles Caton says:

    I continue to enjoy your informative evaluation of current investment conditions.

    • Keith says:

      Thank you very much for the kind words, Charles.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  6. H. Craig Bradley says:

    Very Reassuring, Keith. Buying opportunities always exist for the right industries no matter what the FED or Wall Street Does in the Short Term.

    • Keith says:

      Thanks Craig. It all comes down to perspective.

      As you have heard me say many times, there’s always opportunity in chaos. We just have to be smart enough to buy when we find it.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  7. silvia says:

    Keith I did I miss out on the symbol of a stock Wireless electricity? please send symbol

  8. Dan says:

    I was wondering if you could give an update on the base builders RCS and NQU? In particular, I would like to understand how these react to rising interest rates. I have noticed that RCS in particular does not seem to have a correlation to interest rates. I would expect it to rise in value as rates fall and fall in value as rates rise. The price moves round a lot and I don’t understand why.

    • Keith says:

      You bet, Dan.

      The key is the middle of the yield curve. Like a playground seesaw, there hasn’t been a lot of movement even though both ends of the curve are beginning to show some turbulence. This makes them less correlated to overall rate changes and generally more stable than comparable choices with a more pronounced shorter or longer term duration.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  9. Kenny says:

    Interesting bit of history there Keith. It would be interesting to see how other major global currencies were performing when the Fed increased rates in the past 45 years. Currently, the USD is at near record highs, not because the dollar is strong but rather all other currencies are weak. With a rate increase, if Yellen has the balls to pull the trigger which I highly doubt, will put international markets/corps at a high risk of defaulting. The huge amount of dollar denominated international debt could very well be the cause of the next global financial crisis. I hope you are right with the market/rate increase correlation but i have a nagging feeling any market appreciation may be short lived. Would be interesting to see what REALLY happens in time. Thanks for your insights.

  10. yngso says:

    June was shure thing not long ago. Now they’re talking about Sept or Dec…

  11. NEVILLE says:

    Keith your imput is great and very usefull thanks keep it up love your advice .All makes sense
    NEVILLE

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