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News

Stop Thinking About the Fed!

Aaron Levitt Sep 20, 2015


The last few weeks have been excruciating. And not just because my fall seasonal allergies have kicked in. I mean because of Janet Yellen and the darn Federal Reserve. Almost every piece of financial news has been related back to the decision on whether or not to raise benchmark interest rates. As you recall, in an effort to jump start the stagnating economy during 2008 and 2009, the Fed gave a big “talk to the hand” to savers and plunged benchmark interest rates down to near zero.

Since that time, every market pundit has been trying to predict or estimate when interest rates will rise and by how much. “Prepare Your Portfolio Now!” “45 Investments That Laugh in the Face of Rising Rates!” etc. Checking my own article archives, it was 2010 when I first wrote about the possibility of rising interest rates. Whoops.

And every year, as the Fed essentially kicked the can down the road, the market has gotten even more hyper about the decision. Up is down, good news is bad news, black is white. Till we arrived at Thursday’s landmark decision of…keeping interest rates at zero.


Just be Gellin’ with Yellen


The old Wall Street adage goes, “Don’t fight the Fed.” It should be, “Just ignore the Fed.” Seriously. Go ahead and ignore them because in the grand scheme of things it really doesn’t matter.

For starters, when and how that rate rise finally does come is not going to be as bad as the last five years of rate-sanity suggests. The key thing is that the Fed isn’t going to go from 0% to a 1970s inflation-busting high of 15%. We’re looking at a token 0.25 basis increase; a measly quarter of a percent. That’s more of a gentle nudge than a punch to the face as many people would suggest. The average American car payment would rise by just $18 per month with that sort of increase. You may have to eat at Chipotle only three times a week to cover that.

And you really don’t need to prepare your portfolio for the shock of that gentle nudge. At least not when it comes to stocks. (Bond investors you’re on your own.)

According to data provided by the Bank of Montreal, stocks have actually kicked butt during tightening cycles. Since 1982, there have been seven tightening cycles during which the Fed has raised rates. And guess what? The venerable S&P 500 managed to finish in the black for all of them. Not one year showed a big decline, with the large-cap index increasing an average of 6.4% in the 12 months following the first rate hike. Expanding that further over the full tightening cycle and the S&P 500 averages just under 21% in returns.

That’s pretty decent returns for something that’s supposed to flatline the markets, unleash hell, and end the bull market as we know it. Or at least that’s what the recent bouts of volatility leading up to Fed decision days are supposed to make us believe.

And while some people may now choose higher yielding bonds over stocks, the effects should be muted. Realistically, the people looking to snag a now 3% probably shouldn’t be using stocks in the first place.

Oh and as for all that high yielding stuff like REITs, MLPs, even dividend stocks, they do alright too. After an initial “shock” these higher yielding asset classes actually go on to outperform stocks over tightening cycles. That’s because many of them feature dividend raises that beat anything the Fed’s doing.


It’s the Economy, Stupid


At the end of the day, you need to ask yourself why the Fed is raising rates in the first place. Bill Clinton said it best: “It’s the economy, stupid.” The answer is because the economy is actually doing well. For stocks, that means rising earnings, cash flows, revenues, yadda yadda yadda. All the stuff that drives multiples and share prices. Ultimately, the Fed raising rates is a signal that the economy is actually doing pretty good. You want that and your portfolio wants that too.

And given that Yellen & Crew’s Thursday decision could be a sign of just how anemic growth has been, you should welcome a rate increase.


So Ignore the Noise


CNN Money Digital Correspondent Paul R. La Monica perhaps said it best with his sarcastic tweet in response to the recent Fed indecision.

Buzz tweet buzz tweet buzz tweet buzz tweet

But he’s totally right. If you’re buying stocks, you’re doing so for the long-term, and nothing the Fed is going to do should change their long-term returns picture. Quailty dividend stocks are still going to be quality dividend stocks even if Yellen ratchets up interest rates a few quarters of a percent.

So ignore the noise, buy quality stocks that pay great dividends and enjoy the weekend. Your portfolio and sanity will thank you.

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