Yellen’s Great Interest Rates Game
I am not quite the grandmaster at the classic board game chess, but I do enjoy playing and teaching the game to my kids.
One of the hardest concepts to grasp for a 7-year-old is the need to think several moves ahead.
In August, Mohnish Pabrai took part in Brown University's Value Investing Speaker Series, answering a series of questions from students. Q3 2021 hedge fund letters, conferences and more One of the topics he covered was the issue of finding cheap equities, a process the value investor has plenty of experience with. Cheap Stocks In the Read More
If you’ve ever played, then you may know the idea is to position yourself in such a way that will force the opponent into moves you can anticipate, and make it all work to your advantage.
In a sense, investing is a lot like a game of chess — thinking ahead about where a future stock price will be based on certain circumstances.
That’s what makes stock price movements somewhat predictable, and ultimately profitable — and that’s what we are going to explore today.
Take, for example, the current state of the Federal Reserve. It’s in a constant battle of whether to raise interest rates or keep them historically low.
This is a dilemma I watch constantly and analyze, and next week we get yet another Fed meeting set to conclude on Wednesday, July 27. Afterward, we will get only a press release from the meeting, which is minimal information since Federal Reserve Chair Janet Yellen isn’t scheduled to hold a press conference afterward.
That means investors and analysts will be left scouring the release for the slightest clues on the Fed’s next move.
By thinking several moves ahead, we already know where the endgame will be — lower interest rates for longer than expected.
And that means there are opportunities for us to profit…
Anticipation for Rising Interest Rates
Let’s think about what’s going through Fed members’ minds for a moment. Since the last Fed meeting in June, the landscape has completely reversed.
In June, we were coming off a dismal May jobs report that showed just 38,000 jobs created versus 162,000 expected and a lingering Brexit vote.
Since then, the Brexit vote happened, and the U.K. chose to leave the EU. But markets have rebounded from the initial reaction, which may give the Federal Reserve some ease over the vote. We also had a huge rebound in the jobs report for June, coming in with 287,000 jobs created versus expectations of 175,000 — which is great, as long as you ignore how this blowout jobs number was inflated by seasonal and one-time job gains.
But, will the Fed dig deeper into the jobs data? I doubt it.
So we already know what we will likely get from the Fed: They are happy to see job creation bounce back and stability in the markets after the shocking Brexit vote, but not happy enough to raise rates.
The fact that things appear to have stabilized will keep the possibility for rate hikes later this year on the table. This will cause investors to begin anticipating a rate hike sooner than later — which will not happen.
And that’s where your opportunity will come in.
Checkmating the Fed
In previous articles, I have highlighted several reasons that the Fed’s hands are tied when it comes to raising interest rates by any meaningful amount: Our economy is too weak, the U.S. dollar is too strong and our government debt is too large.
That’s how I know the endgame: Rates will stay lower for longer than anyone is expecting.
After the Fed’s press release, the pressure to raise interest rates sometime this year will ratchet up, putting pressure on interest-rate-sensitive stocks as well.
The utility sector, real estate investment trust (REITs) and high-yielding dividend stocks will experience a sharp pullback.
That will be your buying opportunity.
These sectors have soared since the last time the Fed raised interest rates, even as the broad market became more volatile and expectations for future rate hikes diminished.
If the current market situation gives investors a reason to expect higher rates in the near future, use that to scoop up stocks in those three sectors.
Or, if you want, you could easily grab an exchange-traded fund (ETF) related to each:
- The Utilities Select Sector SPDR Fund (NYSEArca: XLU) below $48.50.
- SPDR Dow Jones REIT ETF (NYSEArca: RWR) below $95.
- iShares Core High Dividend ETF (NYSEArca: HDV) below $79.
After they experience a pullback, investors will start to realize that the Fed simply can’t raise rates by any meaningful amount, and these shares will resume their rally.
Low interest rates are here to stay, and these sectors are where you want to be.