Shortly after Fed Chair Jay Powell started talking in the press conference that followed the FOMC meeting and interest rate statement on Wednesday, it was clear what he wanted to emphasize. No, the Fed was not raising rates this quarter, but he really wanted us all to know that that doesn’t mean that hikes are over and that there is absolutely no intention of cutting the Fed Funds rate any time soon. I’m sorry Mr. Powell, but I don’t believe you and neither, it seems, does the market. Stocks are still showing strong Year to Date (YTD) gains and the yield curve is still inverted, suggesting that traders of all stripes believe cuts are coming.
The thing is, traders learn early to judge anyone in power, whether they be a politician, a CEO, or a central banker by their actions rather than their words, and the FOMC’s action at this meeting was to “pause” 15 months after they started to hike rates. No matter what Powell and other committee members may pronounce publicly, that action speaks volumes. Why would they do that if there wasn’t at least a suspicion in their minds that they have already gone far enough, or maybe even too far, in squeezing the economy? You can say that it is only a pause and that it is a prudent thing to do until you are blue in the face, but any of that is drowned out by the fact that the FOMC felt the need to stop the rate hikes and assess a situation that involves much reduced inflationary pressure and the first signs of weakness in the jobs market.
The…
Shortly after Fed Chair Jay Powell started talking in the press conference that followed the FOMC meeting and interest rate statement on Wednesday, it was clear what he wanted to emphasize. No, the Fed was not raising rates this quarter, but he really wanted us all to know that that doesn’t mean that hikes are over and that there is absolutely no intention of cutting the Fed Funds rate any time soon. I’m sorry Mr. Powell, but I don’t believe you and neither, it seems, does the market. Stocks are still showing strong Year to Date (YTD) gains and the yield curve is still inverted, suggesting that traders of all stripes believe cuts are coming.
The thing is, traders learn early to judge anyone in power, whether they be a politician, a CEO, or a central banker by their actions rather than their words, and the FOMC’s action at this meeting was to “pause” 15 months after they started to hike rates. No matter what Powell and other committee members may pronounce publicly, that action speaks volumes. Why would they do that if there wasn’t at least a suspicion in their minds that they have already gone far enough, or maybe even too far, in squeezing the economy? You can say that it is only a pause and that it is a prudent thing to do until you are blue in the face, but any of that is drowned out by the fact that the FOMC felt the need to stop the rate hikes and assess a situation that involves much reduced inflationary pressure and the first signs of weakness in the jobs market.
The “pandemic distortions” argument that led to the Fed describing this bout of inflation as “transitory” for so long is somewhat discredited now because it led to that mistake, but there is a lot of truth to it, as this chart for the rate of increase in the Producer Price Increase (PPI) from the US Bureau of Labor Statistics clearly shows…
The spike to a high of well over 11% was clearly a result of the pandemic in the Spring of 2020 and the rapid pullback is as much about those problems easing as it is about the Fed’s actions. As usually happens, of course, the initial source of rising prices is not the point once you get a few quarters into an inflationary cycle. Then it becomes about wages rising to try and catch up and whether or not corporations reverse price hikes as input pressures fade, and on both those counts the data is encouraging, if not conclusive.
The Fed sees those numbers and the pause in rate hikes shows that they are now more concerned about having gone too far than not far enough. `So, when Jay Powell assures us that rate hikes aren’t over and that a cut is completely off the table, he may be saying what he thinks is true, but his actions tell us where he really is at this point.
The relevant question, though, is what does that mean for investors or, more specifically in the context of these pages, energy investors?
Well, if there is to be a slowdown in the US and therefore presumably in the rest of the world too, oil isn’t about to bounce back strongly any time soon and, as a result, nor are most energy stocks. What will have increased appeal, though, are the dividend yields that come from some areas of the sector. Rising interest rates devalue those yields, but if rate hikes are over or are even paused for a meaningful time, they will be back in vogue soon. However, if oil prices are vulnerable, high-yielding oil companies and LMPs may not be the way to go.
Utilities, on the other hand, offer good yields and the prospect of growth in almost any economic condition. Not all of them are created equal, of course. Some, such as Southern Company (SO) and Dominion (D), have pulled back from their highs but are still trading at P/Es above the average for the S&P 500, something hard to justify in the typically highly leveraged and capital-intensive utility industry. In some cases, though, the pullback has taken the stocks to at or below market average multiples. That brings in stocks like Duke Energy (DUK), and Exelon (EXC). The yield on an evenly weighted investment in those two would be around 4%, not great in a world where short-term Treasuries yield more, but when combined with historic average price appreciation and dividend reinvestment they produce a solid double figure total return that looks quite attractive given the uncertainty around the future that most people currently feel.
Jay Powell told us all on Wednesday that rate hikes weren’t over, but the pause told us that they may well be. That isn’t good news, though. A permanent “pause” will only happen if there is economic weakness. So, allocating a portion of your wealth to positioning for that now, before it becomes obvious, is a sensible precaution to take, and doing so by way of utilities, where some value can be found, may well turn out to be smart.
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