Let’s cut to the chase: The Fed is totally in charge of the market’s moves in the next few weeks.
Interest rate hike conversations are basically dominating every news article on the capital markets. While everyone knows it’s difficult to predict market returns, we can say with certainty that ‘patient’ will be the most discussed word during Wall Street happy hours on Wednesday evening, depending on whether Janet Yellen utters it in her press conference earlier in the day.
The payoff is simple. If she doesn’t say the word, an interest rate hike is coming soon. If she does, global markets will probably celebrate with some wild, spring-break style partying as the inevitable rate increase gets delayed. And, with central banks worldwide bracing themselves through all possible measures, although well-intentioned, we find ourselves for the next few weeks – more than ever – in a situation where monetary policies are driving stock prices, impacting currency valuations, displacing imports and exports, and making tourists change their plans.
The good old state where economic strength and company fundamentals drive stock prices will come soon, hopefully. In the meantime, making short term moves by trying to predict the Fed’s policy is akin to gambling, and we don’t think it’s worth the risk. So, continue to think long term, and detach from the daily news noise. In light of the projected turbulence up ahead, here are a few investment ideas worth looking into:
– Small Caps: Companies described by the Russell 2000 derive over 80% of their revenues domestically, according to the Bank of America – so, they’re way less affected by international currency trends, including the (increasingly) strong dollar. Per data from Perritt Capital, ‘during periods of dollar increases of 15% or more, small-caps have achieved an annual total return of 13.6% vs 10.7% for the S&P 500’, going back to 1970. Meanwhile, the Russell 2000 has averaged returns of 2.5% 3 months after a fed funds rate increase, 12.6% 6 months after, and nearly 16% a year later, based on Perritt’s data between 1980 to 2005. This sector isn’t cheap from a P/E standpoint by any means, but it’s worth considering an ETF like IWM for a bit of shelter when we look at the dollar’s strength, impending rate increase, and domestic US economic improvement.
– Infrastructure Growth: This is a long term play. According to PwC’s Capital Project and Infrastructure Spending Outlook, ‘Worldwide, infrastructure spending will grow from $4 trillion per year in 2012 to more than $9 trillion per year by 2025’. Meanwhile, according to the World Bank, ‘a 10 percent increase in infrastructure investment contributes to a 1 percent growth in GDP’, and the ‘number of people living in cities [worldwide] is expected to double by 2030’. Infrastructure needs are a no-brainer for the world in the long term – ETFs such as GII and IGF can provide good exposure to this sector in your portfolio.
– Financials and Emerging Markets: Interest rate hikes will bring stocks down – but structurally, the US is rapidly improving. The financial sector hasn’t taken off yet, and we emphasize an investment here for reasons noted in our February 8th column. Meanwhile, remember that active fund managers aren’t paid by their clients to hold cash. As international markets diverge in the coming weeks, they’re going to reallocate their capital somewhere, and you want to be exposed to the countries that will gain from inflows aided by internal structural reform. Per our column on the 26th, India, Mexico, South Korea, the Philippines, and Indonesia top our list. Consider buying and holding ETFs that correspond to these markets, and keep your seat belts on. The ride will be tough as the year goes by, but even if they fall, in the long term you’ll do fine.
What it means for you: Barron’s recently highlighted that ‘the pace of redemptions from hedge funds slowed in January ($8.9 billion) from December($28.1 billion)’. In the ongoing 6-year old bull market, hedge funds have significantly underperformed the S&P 500 – not thoroughly unexpected, as their intention is usually to deliver absolute returns while protecting from downside, as the word ‘hedge’ suggests. The smart money investing in such funds may be suggesting that with redemptions slowing, the markets are primed for a pullback.
Individual investors are notorious for buying high and selling low – meaning panicking when stocks fall. At a time when market turmoil is imminent, a diversified stock portfolio along with a chilled out attitude is the way to go. Sit back, stay invested, take a long term approach, and avoid getting trampled by the bulls, bears, and little guys duking it out on Wall Street in the coming weeks.
