Help Me Understand this Market.
Maybe I’m missing something, but the way certain interest sensitive sectors of the market are acting, especially those with leverage (MLPs, REITs, Utilities and BDCs), you would think a major bump in interest rates (maybe even tightening by the Fed) is imminent. Can you tell me from whence this is coming? The Fed is not delivering this message. The economy is fine, but not red-hot. Inflation seems to be under control.
OK. If you can’t answer my first question, how about this one? What harm would a quarter point increase in the Fed Funds rate (from essentially zero) do to the economy? Or, for that matter, what damage would further gradual rate increases do, if taken over the next 12 to 18 months? Historically, a one or one and half percent fed fund rate would still be way below the level of Federal Funds that we have endured and prospered under over the past 6 decades. For those that doubt the veracity of my assertion, please check out this report from the St. Louis Fed on Effective Fed Fund Rates since 1954. BTW, the Dow Jones Industrial Average closed out 1954 at 404.39. It closed Friday, October 2, at 16,472.37.
Another way to address these questions might consideration of two more questions:
1) What would be the impact of a 1.5% FF rate increase on longer bond rates (10-year U.S. Treasury rates)?
Based on recent history, a worse case estimate might be a one-to-one increase in the 10-year. Say to 3.50%. More likely, it would be much less than that (maybe even lower), due to the pervasive fear that exists in the market. There are those that believe even a small move in rates would throw us into a recession or worse (see comments below from Carl Icahn). Many are fearful that we are on the cusp of another 2008 event, even if they can’t exactly explain why … a flight to safety. Ergo, rates on the long-end could remain low for a long time.
2) Another looming question–What is the potential impact of higher rates on business capital spending, individual consumption and housing?
The impact of moderately higher interest rates, as it pertains to capital spending, should be de minimis. If you are operating on that tight a tolerance (i.e. where the additional 1.5% would make the project uneconomical), maybe the project should not be undertaken anyway. Also, as it pertains to capital projects and home ownership, maybe the threat of rising rates moves those who are ‘on the dime’ to take action … do it now before rates go up.
3) Finally, would 3.5% rate on a 10-year bond be stiff competition for a stock yielding 3%, a stock where dividends and earning might grow over time?
From a purely competitive standpoint, you don’t need fast growth to make the stock compelling. Four or five percent will do quite nicely. So, the answer to the bond being stiff competition for a stock would be, probably not, especially as we hold the view that rates will not move up that rapidly (again, they could easily go lower).
So, why are we so obsessed by this?
It is because the media and punditry are obsessed. Of course, they do not provide history or perspective, except when they say this will be the first time in nine years that the Fed will raise rates! And, then they will leave you with the distinct impression that raising rates is a bad thing, and that the fate of the world hangs in the balance. This is how they get paid! If you go back, even in recent history, and see how many times they got it wrong, you will be appalled. Remember these world-ending events?
- Passage of The Affordable Care Act (AKA, Obamacare)–It would put a lot of companies out of business and people out of work,
- The Sequester–numerous government shutdowns and the dreadful end to Quantitative Easing.
The market made new all-time highs after each of these, much-hyped events! The new ‘worse thing’ that could possibly happen is Lift Off, the Fed raising the Fed Funds rate 1/4 point. Give me a break, or as I requested earlier, “Help!” me understand why this time it will be different.,,why the media might have it right.
‘Piling on’ part II
With the market on the ropes earlier last week, two well-known pundits (hedge fund operators), Carl Icahn and Jeffrey Gundlach, tried to give it their best shots to take the market lower. Mr. Icahn is seeing “danger ahead”, the potential of another 2007 bubble bursting, was out warning about the evils of debt, financial engineering (something he is expert at). He has great things to say about Apple (a very large Icahn position), while badmouthing others using similar policies. So, he likes AAPL and must be short other equities and junk bonds. This is ‘talking your own book’ in the highest order. William Watts, a contributor to MarketWatch, takes Icahn to task in “Why Icahn’s Danger Ahead video is funny, not scary.” Then there is Doubline Capital’s Jeffrey Gundlach, essentially out doing the same thing in this little piece, “Doubleline’s Gundlach: Expect ‘another down wave’. “ This is not new news. It is just a couple of guys with big reputations talking their own books … piling on.
What’s your take?
The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. All investments and strategies should be undertaken only after careful consideration of suitability based on the risks, tolerance for risk and personal financial situation.