Don’t Fight The Fed
Stocks continue to flirt toward new highs on the Dow Jones Industrials. A record on the broader S&P 500 hangs only a few points above its recent levels. The economic recovery remains fragile after the Congress stumbled into across-the board spending cuts through its spineless sequester and raised taxes Nearly all economic forecasters agree that these bonehead acts will subtract from economic growth this year.
Fortunately for investors, the Federal Reserve continues to keep its accelerator pressed to the floor. One of the more useful Wall Street sayings is “Don’t fight the Fed” and its actions since the financial panic have strengthened this reputation. This week, Chairman Bernanke reaffirmed its policy to keep short-term rates near zero until the unemployment rate drops to 6.5%. This critical index has moved from 8.1% last August to 7.7% last month. Mr. Bernanke described this improvement as both partial’ and “modest,” making clear that further improvement is needed before the Fed changes its stance.
The Fed’s easy-money policies are popular on Wall Street and have doubtlessly contributed to stock market highs. The record low interest rates spawned by its policies have been particularly helpful to bond prices. At some point, the Fed’s supportive policies must end and the ensuing interest rate increases shred bond prices.
If an investor holds a bond to maturity, it is probable that the company will then pay its par value, but waiting for maturity can be a long time. For example, a 30-year investment quality bond paying 4.5% interest would lose 14% of its present value upon only a one percent increase in rates. A two percent increase would cut its value by 26%. In today’s market, solid, dividend-paying stocks look better.
There is still time to adjust. Interest rate increases appear to lie sometime ahead as the Federal Reserve foresees unemployment remaining high well into 2015. Its accompanying forecast for the economy is a 2.3-2.8% rise this year, not enough to quickly drive down unemployment. Next year, it sees an increase to 2.9-3.4%.
This environment is well ahead of the European economy, which continues to lurch from crisis to crisis. It provides a decent playing field here for stocks of larger U.S.-traded companies. Investor anxieties make careful stock selection essential. FedEx, for example, plunged on disappointing earnings attributed to customers seeking less costly shipping methods. Oracle fell short and blamed these results on its sales team, hardly an example of inspired business leadership. Caterpillar fell short on falling sales other than Latin America.
Among my recommendations in these same three sectors, Union Pacific (UNP-$138), Int’l Business Machines (IBM-$211) and Deere (DE-$87) all report earnings in mid-April. Valuations are moderate on all three and I expect to add to positions if price weakness develops as we near their earnings reports.
Financial stocks often lead market rallies, reflecting their forerunning positions in the economy. JP Morgan Chase seems to have a new scandal every week but is trading near its 52-week high on expectations for moderate earnings increases. Wells Fargo and American Express seem steadier but I am confining my bank buys to even steadier U.S. Bancorp (USB-$33).
Aflac (AFL-$51), a supplemental health and life insurer, reported disappointing results last month, prompting analysts to reduce 2013 earnings forecasts to around $6.35, down slightly. Even if those don’t improve, that’s a modest P/E ratio on only 8. Aflac looks good for patient investors with a 2.7% yield, increased for 19 straight years, and an improving economy in Japan, source of over half its sales.
Cigna (CI-$61), one of the largest health insurance companies, reported $6.00 earnings for 2012 and is headed for higher figures this year. Buys now look timely in advance of its April earnings report. This is not a time for heroics (It never is.) but taking advantage of good prices in quality stocks will work.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. [email protected] 949.494.1376/