Who Will Win And Who Will Lose When The Fed Raises Rates In December
Summary Analysis of the jobs report. Explains why bonds and other interest rate sensitive investments will suffer. Explains why stock picking through logic and common sense is back. Today, we had great news as the US jobs report finally showed signs that the economy may be improving as 271,000 jobs were created, beating economists’ estimates of 180,000, while the unemployment rate fell to 5% for the first time since 2008. This is where the jobs were created: (click to enlarge) But the most important thing about the report is that the average hourly wage finally spiked up for the first time in a long time. Janet Yellen and her gang at the Fed are going to party this weekend, as the release valve from the tremendous bone crushing stress that the Fed officials have been under has just opened, and this report is all the evidence the Fed will need to raise interest rates (for the first time since 2004) when it meets in December. That means that the party of free money at zero interest rates will finally come to an end. The Fed will start raising rates in December and then will probably start raising rates at about .75% per year for the next 5 to 7 years, bringing interest rates eventually in line with the historical average rates. Who will suffer and who will benefit? Well, those who will suffer are: 1) Anyone owning commodities like gold, silver, oil, etc., as the US dollar (NYSEARCA: UUP ) will continue to rise, and since many of these commodities are priced in US dollars, they will fall. You can see evidence of that in the price of gold (NYSEARCA: GLD ), which just hit a 5-year low today on the news. (click to enlarge) So anyone owning commodities or the companies that mine them (NYSEARCA: GDX ) is in for some serious pain going forward. Now, the only thing that can save commodity producers and miners is if inflation starts its way back up. The Fed has to move quickly as the last time we had such low interest rates was in 1973, and from 1974 to 1980 inflation erupted and interest rates went from 3% to 19% in six years. We are currently in a deflationary period and there is little threat of inflation right now, but the Fed needs to get ahead of the curve and move because hyperinflation is serious business, and if one ever lets that genie out of the bottle, it is almost impossible to curtail it. 2) Bond holders (NYSEARCA: TBT ), insurance companies, dividend investors, car manufacturers and dealers, home builders, realtors, furniture/appliance manufacturers, utilities and companies doing buybacks will start feeling the pain coming up. Since investors will start getting higher interest rates on new bonds issued and with savings deposits at banks, with every quarter-point rate increase by the Fed, those holding older bonds will probably sell them to buy the new ones issued at a higher rate. So, what you will see is the opposite of how refinancing your house works, for example. When you refinance your home, you pay off your old mortgage and get a new lower rate. But when you refinance your bonds, you are looking for a higher rate of interest and thus will sell them to buy the new ones. So those holding older bonds will see investors in those bonds sell them, chasing the higher rate and buying new ones. When they sell, the principal of those older bonds goes down as the yield that each one pays has to match the new bonds. So, if rates keep rising, then more and more people will be selling their bond holdings. The biggest holders of bonds are insurance companies (NYSEARCA: IAK ), so insurers will feel the pain as the products each offers, like annuities, will need to pay higher rates of interest to stay competitive, while the principal value of each companies’ bond holdings will slowly decline. So for insurers, it’s a double-edged sword. Dividend investors will suffer as the army of investors chasing dividends will have another safer option to invest in to get interest (like CDs at banks) so companies such as utilities, master limited partnerships (NYSEARCA: AMLP ), REITs (NYSEARCA: IYR ), etc., will have to raise dividend rates, which means each will have to borrow more at the new higher rates to pay them. As each borrows more, the underlying business suffers as costs increase, but revenues and profits stay the same. In my opinion, interest rates will constantly rise at about .75% per year, thus those companies currently borrowing at zero interest rates will no longer be able to do so and thus will curtail buyback plans and stop raising dividend payouts. Management will actually have to grow their companies’ bottom lines and invest in growth. This action will be a paradigm shift and will spur capital expenditures, which will grow the manufacturing base, and those companies that make industrial equipment (NYSEARCA: IYJ ) may benefit. As interest rates rise, home prices will stop rising and demand will slow as mortgage rates will go up and that will hurt home builders and realtors (NYSEARCA: ITB ) as there will be fewer buyers and a lot more sellers. Those who have been successfully flipping houses will finally find an urgent need to dump their entire portfolios of homes in a hurry. Back in 2009, hedge funds bought millions of homes in foreclosure and have since seen those homes rise in value. I would assume these hedge funds will start flooding the markets by putting those homes all up for sale ASAP. So, if you were thinking of selling your home, you better move it. Utilities (NYSEARCA: IDU ) will start to tank as the only reason investors really buy them is for the dividend yield. Since maintenance CapEx charges on utilities have always been very high, utilities, in order to pay out a dividend, have always borrowed money to do so. Thus, each will suffer as interest rates rise and borrowing costs do so as well. The party for car manufacturers and dealers will soon be over as each will no longer be able to offer zero interest rate financing. I went and bought a new Toyota (NYSE: TM ) Tundra truck recently as I wanted to lock in the rate but will not be buying anything again for ten years. So if you are in the market for a car, go buy it soon. The same goes for furniture and home appliances; lock the rates in because you will not see these sweetheart deals anytime soon. Those who will benefit from rising interest rates are: 1) Stock pickers will benefit as investors start to rebalance their portfolios, removing those industries mentioned above and go for more growth and value investments based on each company’s Main Street operations instead of dividend payouts and buy backs. I have not been in a rush to buy anything as I knew this scenario and major paradigm shift was coming and that the markets would be effected as a rebalancing of portfolios will start soon. The companies I have bought have extremely high free cash flow and thus are not going to be much affected by rising interest rates. Most of them are duopolies like Lockheed Martin (NYSE: LMT ), Boeing (NYSE: BA ), Visa (NYSE: V ) and MasterCard (NYSE: MA ), while others operate with very little, if any, debt at all like FactSet (NYSE: FDS ) Biogen (NASDAQ: BIIB ), Michael Kors (NYSE: KORS ), Gilead Sciences (NASDAQ: GILD ) and Accenture (NYSE: ACN ) and have FROICs of 30% or higher. For those interested in more information on how I picked those stocks, you can find out more by going HERE . I also own Apple (NASDAQ: AAPL ) and here is my Friedrich Research on it that shows you why I bought it: (click to enlarge) Multinational firms may suffer due to the strong US dollar, so the smart investor may want to concentrate on those companies that buy supplies or have products manufactured outside (like Apple does) of the US, as the stronger dollar will buy more bang for the buck while those who export will suffer as customers overseas will be buying less as their currencies weaken. Going forward, what is coming up will be a stock pickers’ dream market, where those who should outperform are those who actually do the research and due diligence to get the story right. Investors will no longer be able to buy anything and watch it go up automatically, as the rising tide will now just be calm water and will no longer lift all boats. Investors will need to buy the right stocks and get the story right. The free ride of markets backed up by the Federal Reserve’s zero interest rates will be officially over when the Fed raises rates in December. The next few months will be a rebalancing of portfolios toward growth and value investing instead of index/dividend/buyback investing. Analysts, portfolio managers and stock brokers are now going have to actually work for a living as the free ride of just putting their clients’ money in index funds, bonds and ETFs and watching them go up every day automatically (as more and more people pile in) will no longer be profitable as the party there is over. As a result, more and more people will become confused at this paradigm shift, as most of them were not investors prior to 2004 and don’t know what a rising interest rate cycle is like. Once the Fed starts raising rates, it usually raises for 5 to 7 years, but the Fed will be raising for at least that much this time around, as it is starting from zero and that’s a long way away from the historical average rate. So, in conclusion, the tide will now start rolling out and you will finally see those who are naked and without a clue on how to invest, as they can no longer rely on the Fed Tide lifting all boats. Momentum investors will get crushed as those companies that buy other companies with zero debt will finally not be able to do so anymore, so mergers and acquisitions will come to a screeching halt as will IPOs. As for me, I am very excited as I will be using my Friedrich algorithm and slowly building a strong portfolio of growth/value investments that I can hold for a while as the Fed begins its moves in December. Those who will benefit are those who use logic and common sense, and more importantly, who know what they own and why. With the Fed out of the picture, as of December, logic and common sense should rule the day.