Today the Fed hit the pause button on the stock market's advance by making it clear that it favors more hikes this year than we thought. We had come to believe that only trade wars could derail stocks, but the data's too hot, the economy's growing too fast, and the Fed can't just sit back and let it unfold.
So, it's doing the prudent thing, raising rates and suggesting that it might have to throw in one more raise than we thought, four instead of three, and that made buyers pause from their endless shopping spree and reassess the gains that had become commonplace because of strong employment, a synchronized global advance and excellent earnings gains.
So what do you do?
First, understand that owning stocks just got harder because higher rates are not a positive for stocks. I almost feel silly writing that because stocks have been going up despite the increase in rates but you have to understand that with each rate hike you lose bulls because plenty of investors think that that this market is only about low rates. Plus, the market plummeted and then came back ever so slowly as the afternoon progressed when Fed chair Jay Powell in a well-run press conference, allayed fears that we were going to get a rat-a-tat-tat set of hikes no matter what. So there is zero reason for panic. ZERO.
Still when you get higher interest rates then you get a higher number of people who are fearful of owning stocks and want to own bonds. It's a pause, not a correction, but a pause is something that's not been in the cards of late.
Second, we have hotter inflation than we did not that long ago, so the Fed has to take this more aggressive action. Many investors have been lulled into thinking that inflation isn't coming back. But when Jay Powell says the economy is better and has accelerated that's enough for some buyers to think that the halcyon low inflationary times are over. I think that's superficial. There are a lot of deflationary forces out there, notably the digitized economy that produces lower prices for all. That doesn't matter today or for the foreseeable future, though, because the Fed has spoken and when the Fed accelerates rate hikes, as they did today, that's enough for lots of bulls to hit the exits.
Higher rates trigger a rotation that's jarring for many and they don't like the whippy market that changes course on a dime. Today we got the long-awaited rotation into the banks and out of the housing and housing related stocks. That makes sense: mortgage rates are going up and that's negative for the homebuilders and terrific for the banks. The increases in short term rates are incredibly positive for the banks because they make much more on your deposits with four rate hikes than three rate hikes.
Let me just say that these are some of the cheapest stocks in the market. That's' because there had been a consensus going into this meeting that the Fed would wait before it switched its view that it might give us four hikes and not three.
That consensus was wrong. JPMorgan is the premier commercial bank on earth and I think that it is reasonable to believe that many analysts will come out and say you have to buy the stock. I think Goldman represents the best buy here in part because it has underperformed badly and in part because the court decision that allowed AT&T (T) to buy Time Warner (TWX) is going to unleash a wave of mergers that will be incredibly additive to its earnings. Plus, at the end of the month the Federal Reserve will release its report cards for banks and I think Goldman Sachs will get a clean bill of health and immediately announce a gigantic buyback. It's been a terrific second half performer; I think this time will be no different.
As for those homebuilders? They've been bad stocks to own for ages. They will only get worse given that mortgage rates will go up and timber's not coming down because of our trade tiff with Canada. We don't grow enough trees in this country to keep lumber down. Plus, labor is getting scarce so their margins will get squeezed.
Retailers will not get the benefit of the doubt here, at least for a few weeks as they have had a big run and investors often believe that purchases are done on credit cards and the cost of credit card debt will go higher. Ultimately retail is far more sensitive to employment than interest rates but we are in the Fed blast zone for the moment so you can expect the group to be weak. It could be a terrific opportunity to get back in after a 5% to 8% decline but if you buy before then you could be courting a "too early" verdict.
The consumer packaged goods stocks tend to sell off when we learn of more rate hikes than we thought because lots of investors own these stocks for their dividends and their growth. Lately their growth has been meager and their dividends are pretty much a wash versus the 10-year treasury. Now, though, these companies have seen their margins squeezed by the raw costs and transportation costs that came up as issues with this morning's too-hot producer price index number. And we should be able to get a short-term CD for the same rate as these companies are giving you. Lately the consumer product stocks have either stalled or have been creeping higher. I expect profit taking. I told members of the actionalertsplus.com club that they can hold on to fast growers, we like PepsiCo (PEP) , but slower growers with dividends below 3% are going to come under pressure.
Tech and industrials could pause both because of worries about trade and concerns about a worldwide slowdown. I know it seems pretty ridiculous to think that four rate hikes instead of three can make a slowdown materialize out of nowhere. But you will hear chatter of emerging market woes. I say woe is me, that's just a staple, but people will freak out. You will hear that we are going to have a much stronger dollar, which hurts these stocks. Remember the way the market works. You can easily craft a scenario that says things are going to slow because of tariffs and rates and no one is going to disagree. Too dangerous. I think that the economy's just fine. But you can understand why someone will pull in their horns because the Fed wasn't as dovish as they can hope.
The big exception to this view? FANG. I know, how repulsive these stocks can be to those who don't own them or pronounced them dead multiple times. Here's the deal, though. You know how FANG became FANG, something I know because we came up with FANG? It's because they don't need strong growth to propel their earnings. They have individual drivers that make it so the economy is almost irrelevant. Facebook (FB) and Alphabet (GOOGL) are taking share in advertising from traditional media and that's accelerating. Netflix (NFLX) , we just learned from Goldman Sachs, is about to inflect, meaning that it is about to start making a lot of money, something that most people do not expect. Amazon's (AMZN) just a horse. Its advertising business is doing better than expected. Its web services business is riding the wave of the on premises business moving to the cloud. It's at the heart of digitization. And its retail presence just grows and grows and grows regardless of the state of the economy.
Now, these are all generalizations. Rates are low enough even after the hikes we have had and the ones we now expect. So, it's a pause. Plenty of stocks can go higher in a pause mode. It's just not likely to be the same stocks that have been going up and that's' an important distinction for those who thought we were done going down because earnings have been so positive for so long.