How To Play The Fed’s Next Move

The outlook for interest rates in the U.S. changed significantly this week with even Jay Powell, now famous for insisting that inflation would be “transitory”, admitting that pandemic-related supply chain disruption will last longer than he had anticipated, and calling price rises “frustrating”. That and the predictable but still ridiculous ritual dance in Washington over the debt ceiling has made stock traders nervous, and the major indices have fallen significantly over the last few days. Even in that environment, though, energy stocks have done well, and a lot of analysts and pundits are saying that they will continue to do so and are a good place to hide during any future volatility.

There are clearly reasons that is true, but it may pay to look beyond the most obvious stocks.

A large part of the reason for energy’s outperformance is that oil has remained strong as stocks have waivered. That isn’t really surprising because the inflation that is making Powell so edgy means higher prices for commodities too, and oil companies would obviously benefit from that. The problem is that oil has been strong for a while, so a lot of the potential is already priced into stocks like XOM, which has nearly doubled over the last year.

That strength, though, is based on restricted supply more than anything, and with increasingly loud talk of output increases being agreed upon at next week’s OPEC+ meeting, that situation may change. Admittedly, there is good news on the demand front, such as the agreement amongst G7 nations to work towards restoring international travel and a growing acceptance that we will just have to live with Covid-19 to some degree and that further shutdowns aren’t really justified. However, those things would be at least offset by increased OPEC+ production, so the upside for oil looks a bit limited for a while.

I still believe we move higher before the year ends, but the big jump in energy stocks doesn’t leave a lot of room for them to go much higher from here unless oil really soars, and there may be more potential elsewhere.

My preference would be for stocks in the alternative energy space. The Biden administration won’t make expansion easy for big oil, but any infrastructure measures will almost certainly benefit solar, wind, and other alternatives, so that is where I am looking.

Still, with interest rates set to rise, some of the younger, heavily indebted firms in the space will face headwinds, so my preference is for mature companies with solid balance sheets. That leads me to an old friend, First Solar (FSLR).

FSLR is far from debt-free with around $469 million on the books, but they also have cash on hand of $1.77 billion, and a debt-to-equity ratio of 8.11 as compared to something like rival CSIQ, with around 109. Add in a current ratio of nearly 5 and First Solar’s balance sheet looks quite healthy.

That will be a big advantage as interest rates start to rise and the cash on hand will enable FSLR to take advantage of growth opportunities that come along. Right now, the analysts’ consensus view is for a drop in revenue next year from this year’s forecast $2.93 billion to $2.77 billion, but that underestimates the competitive advantage that their strong balance sheet affords them.

Q4 of 2021 will be an interesting time for traders and investors. We have become accustomed to doing our thing with a background of ultra-low rates and accommodative monetary policy. That looks like changing soon, but the market has already priced in some of the change, so you need to look beyond the obvious for value. FSLR won’t be hit too hard by rising rates, has a political advantage right now over oil companies, and has a cash position that may enable the company to grow beyond expectations. All that makes it a good pick for the next few months.