After Today's Fed Decision, this Sector Could be a BIG Winner

In just a few short hours, the Federal Reserve will reveal its latest interest rate and balance sheet plans. My research suggests one sector could be a BIG winner, assuming the Fed says what I expect it to.

More on that in a minute. But first, let me paint the big picture here. The Fed has been meeting over the past two days, and is expected to announce how and when it will start selling short-term debt securities from its whopping $4.5 trillion balance sheet.

The Fed started amassing that horde of securities after the credit crisis, when it found itself with the daunting task of stabilizing the economy and getting people back to work. The Fed provided bailouts for banks through the Troubled Asset Relief Program (TARP) and helped over-indebted mega companies like General Motors (GM, Rated “B”) and Fiat Chrysler Automobiles (FCAU, Rated “C+”) find a second life.

They also bought epic amounts of bonds on the open market to inject liquidity into the system, raise confidence, and stoke investment, growth and inflation. That liquidity often just found its way into equity markets instead, though, and sayings like “Don’t Fight the Fed” and the “Bernanke/Yellen Put” become popular.

Regardless of how the money was used, the result was to swell the Fed’s balance sheet to around $4.5 trillion, $4.2 trillion of which is classified as “Securities held Outright.” In comparison to the Fed’s total balance sheet assets, that number is staggering:

Source: Federalreserve.gov

So what now? I’m expecting to see a plan for the unwinding, or selling, of those bonds on the balance sheet. No, not all $4.5 trillion all at once. But a significant amount over time. Some analysts expect a wind down to a more comfortable $2 trillion to $3 trillion level is in the offing. That’s still a lot, so any details on the Fed’s time horizon for portfolio shrinkage will be critical.

What can we expect as the Fed sells off its bonds? Volatility will likely rise, and the complacency we’ve seen so far in this rally should dissipate. Stocks that provide big yields but little growth, like some utilities and telecoms, will likely go back to being laggards, rather than leaders.

When interest rates rise, industries that are sensitive to borrowing may also see profits crimped, and their growth may slow. But others that depend on lending will see their margins increase, and as long as volumes remain stable or grow, profits will also follow.

That’s why my favorite sector to watch is the financials. They had a nice move after last fall’s election, but then they started to underperform. We’re seeing that change again now, with the KBW Nasdaq Bank Index rallying 4.5% since September 7 in anticipation of the Fed’s moves. I also like that financials are generally overweighted by our Weiss Ratings model because of their attractive valuations, more-generous payouts and strong solvency metrics.

Bottom line: If you’re looking for a post-Fed investment play, check out the financials! Here’s a current list of the highest-rated financial stocks (with market caps of at least $50 million and average daily trading volume of at least 50,000 shares):

Keep an eye on the market reaction after the Fed’s announcement at 2 p.m. today.

If it delivers as I expect, financials could see significant upside momentum, and you’ll want this list of potential “BUYs” handy.

Best,

Mandeep

Small Cap Edition, By Mandeep Rai, Senior Analyst Mandeep Rai has more than 15 years of investing experience, working as both a stock and credit analyst. At Weiss Ratings, he researches and evaluates financial and economic themes, and makes decisions on when to buy or sell specific shares for the Top Stocks Under $10 portfolio.