This Week’s FOMC Meet May Trigger Stock Rotation
US stock investors could rotate out of high-yielding sectors and into stocks of banks, which would benefit from the next leg up in interest rates, after the FOMC’s policy-setting meeting wraps up Wednesday.
If the FOMC gives a nod to rising inflation or focuses its trimmed-down bond buying on longer-dated bonds as it winds down its balance sheet, there could be a shift around of preferred sectors.
In the short run financials will benefit if the Fed’s action pushes long-term rates higher relative to short-term rates.
This week’s meeting is not expected to result in an interest rate increase, but investors will focus on how Fed Chairwoman Janet Yellen characterizes recent inflation readings, for clues to the likelihood of a hike in December, as well as on how the central bank will begin to wind down its $4.5-T balance sheet.
Inflation has been persistently low but Ms. Yellen could dismiss this as transitory and point to recent stronger-than-expected data on consumer prices.
Any heightened expectations of a rate increase could fuel a rotation changing the leadership among the market sectors, favoring financials, industrials and materials, putting pressure on utilities and telecoms as well as on companies that consistently increase quarterly paybacks to shareholders.
Investors typically sell shares of utilities and telecoms, as well as high dividend payers when interest rates rise, partly because they lose their appeal as bond proxies since investors can expect similar returns investing in bonds, which are seen as safer assets.
So far this year, the S&P 500 banking index is up less than 4%, underperforming the 9.2% gainer in the S&P 500 dividend Aristocrats index. S&P 500 utilities are up 12%.
This week investors will look for any Fed reveal on its preference for shorter or longer-dated bonds when it reinvests a portion of its maturing assets.
If the focus is on the repurchase of short-term assets, that would likely push the long end of the yield curve higher, driving investors’ attention also to shares of banks, which would theoretically make more money with the help of higher net interest margins, said Morganlander.
Banks borrow money short term and lend it out longer term, so a steeper yield curve is seen as positive for their balance sheets.
While the Fed’s QE program was a pillar of the US stock market’s march from then-12-year lows on the S&P 500 on 9 March 2009 to the current record-high levels, winding it down is not expected to produce a major market reaction to the Southside.
The central bank is expected to initially trim no more than $10-B per month from its $4.5-T portfolio, with the cap rising each Quarter for a year until it hits $50-B monthly.
The slow and steady move would not turn the Fed into a seller. The Fed would allow assets to mature without reinvesting the totality of those maturing assets, which would trim some $300-B from the portfolio after the 1st year.
The boldest, the most Hawkish case, it is going to take well into the next decade for the balance sheet to get to its ‘new normal’ size.
The Big Q: Can the market take it?
The Big A: I say, Yes.
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|Bullish (0.30)||Bullish (0.45)||Neutral (0.19)||Bullish (0.25)|
Have a terrific week.