Fighting The Fed: What Does It Mean?

Investors eventually learn not to “fight the Fed.”  The Fed has more power and a lot more money than you do.

It is popular in the investment punditry to criticize the Fed, blame the institution and the members for all problems, and claim that nearly anyone could do a better job than the incumbents.  It is great fun in the Will Rogers tradition, and very popular in the blogosphere.  The audience is heavily skewed toward Tea Parties.

Most of the popular bloggers and big-time pundits commenting on the Fed have been wrong at every point.  First they failed to predict what the Fed policy would be.  This is actually the most important thing for investing.  Having missed that boat, they then criticized the actual policies.  Finally, even though the policies seem to have stabilized the economy, they argue that we have “only delayed” the final result.  This Limbaughesque approach is only good for page views.

Instead, let us try to make money on our investments.

Fearless Forecasts

Sometimes I write an article that takes hours to develop and document, only to learn that few read it.  Let me take a different approach.  I offer some conclusions based upon extensive analysis, but I am not going to write it all down at this moment.  Here are the conclusions.  I will expand as circumstances and the situation warrant.

Background. Fed Chair Bernanke, in written testimony (actual appearance snowed out) offered  some comments about how the Fed would gradually unwind the extraordinary policy measures employed over the last two years.  None of this should be a surprise.  In fact, many critics have clamored for some clarity.

With the snow on the east coast, some felt that today’s trading was not meaningful.  The facts are that the market sold off by 0.5% or so on the statement and most journalists saw it as the negative news for the day.  Most media observers thought this was a big deal.

Conclusions. In particular, how will a change in Fed policy affect stock prices?

• Everyone knows this is coming.  Interest rates are at zero.  They can only move higher.
• This signal is far in advance of the policy change.
• The moves are intended to remove extraordinary accommodation.
• This is not the same as “tightening.”  We may be years away from a Fed policy that is actually restrictive.

Briefly put - some will mistakenly equate a return to normal interest rates as a bearish sign, a loss of stimulation.  In fact, it is a sign of economic recovery.

More Evidence

Three years ago I wrote an article that was one of my best - at least on my own scorecard.  It was not very popular, perhaps because it involves methodology and takes some work to follow.  You can check it out here.

The main point is that when interest rates are extremely low, the “Fed model” approach breaks down.  No one believes that an interest rate of 1% implies a stock P/E of 100.  When rates get too low, it is a sign of danger.

So here is the key takeaway -

As interest rates move higher, it is a sign of strength.  It will signal P/E multiple expansion.

That is not an opinion.  It is a conclusion based upon data.  There may be a negative, knee-jerk reaction, but increasing interest rates are actually a positive sign - at least until normal levels are reached.