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Fed fear. It’s so thick on Wall Street you can cut it with a knife.
Some investors are worried about a faster pace of interest rate hikes. Others are worried about the winnowing of central bank balance sheets. Still others are worried that incoming Federal Reserve Chairman Jerome Powell will be more hawkish than the newly-departed Janet Yellen.
But I suggest everyone take a deep breath, and I’ll tell you why: My work suggests it’s just too early to freak out about the Fed. And that work is based, literally, on decades of data and personal experience analyzing the interest rate markets.
Let’s start with a quick, important lesson on rates. When people talk about the level of interest rates, they’re often referring to “nominal” ones. Those are the rates you see quoted in news articles, shown on financial websites, and so forth. The Fed just left its nominal federal funds target range at 1.25% to 1.5% at its policy meeting this week, although the post-meeting statement suggested an increase could come as soon as the next gathering March 20-21.
But in many cases, it’s “real” rates that matter more. Real rates are simply interest rates adjusted for inflation. When they’re deep in negative territory, that means monetary policy is still stimulative. It’s helping support economic growth, employment growth, and so on. When real rates are strongly positive, that means monetary policy is the opposite. It’s acting like a brake on the economy.
So where do we stand now? As of December (the most recent month we have data for), the Consumer Price Index was rising at a 2.1% year-over-year rate. The funds rate target, as I just mentioned, has an upper bound of 1.5%. If you take the NOMINAL funds rate (1.5%), and subtract the INFLATION rate (2.1%), you get a REAL rate of -0.6%. That’s NEGATIVE 0.6%.
Now take a look at this chart below. The bottom panel shows the history of the real funds rate going all the way back to the late-1990s. Time periods shaded in green are when the real funds rate was positive, while areas shaded in red are when the real rate was negative.
Source: Bloomberg
See anything peculiar?
Except for a brief period in 2015, the real funds rate has been in negative territory since the end of the Great Recession ...
It’s still in negative territory now ...
And it’s absolutely, positively NOWHERE NEAR the strongly positive levels of 2006-2007 and 1999-2000! As you might recall, those strongly positive levels occurred right around the time the last two economic expansions petered out, and the last two bull markets met their painful deaths.
Suppose you want to use an interest rate that’s less directly controlled, yet still influenced by the Fed? Okay, fine. This chart shows the real 2-year Treasury Note yield – the nominal 2-year yield minus the CPI:
Source: Bloomberg
If you squint and look really, really closely, you’ll see that this rate just popped into positive territory this week. But we’re still only talking about five basis points, or 0.05%. At previous economic and market peaks, it topped 300 basis points, or 3%.
See what I’m getting at here? It’s not that the Fed doesn’t matter. It does. Policymakers have repeatedly inflated asset bubbles for decades – in dot com stocks, housing, and more. And they’ve repeatedly killed off those asset bubbles through restrictive rate policy.
But these charts show we’re far from the maximum “Pain Point” where freaking out would be entirely justified – and far from the point where shorting the heck out of the stock market would likely pay off handsomely. What I expect instead is a more selective phase, and a more volatile one, for this bull market. It’s one where just buying and holding an index fund is probably the worst thing to do, and where you need to instead find and invest in only the strongest stocks in the best sectors.
That’s precisely what I’m doing in my High Yield Investing newsletter, which you can easily join by clicking here or calling my customer service team at 877-937-7778. Or if you’re not quite ready to take that step, at least use the Weiss Ratings available on our website to screen your current holdings … get rid of the dreck ... and trade up to stocks that score better on our impartial, time-tested Ratings scale.
Then when monetary policy does get more restrictive, and the economy does show signs of topping out, you can bet I’ll sound the alarm as loudly and often as possible. That’s what I’ve done in the past, and I won’t shy away from doing it again. And that’s when it’ll make sense for you to get ultra conservative in your investment portfolio.
Until next time,
Mike
