What The Fed’s Rate Hike Pause Means For Stocks

Last week, the Federal Reserve decided to pause its rate hiking efforts to slow down inflation.

Fed Chair Jerome Powell made it clear that the central bank is not done fighting inflation yet, and that this is just a brief pause to allow the committee to observe how the rate hikes impact the economy.

From where I sit, they are slowing economic activity without pushing inflation back to the 2% level.

Here’s what that means for stocks…

The Fed made it clear that it is not done raising rates, as the infamous dot plots call for two more rate hikes this year, increasing the terminal rate to 5.6%.

Fed officials expect to see rate cuts starting in the first quarter of next year and continue until Fed funds rates are back under 3%.

Over at the Chicago Mercantile Exchange, the Fed Watch tool shows that traders expect similar results. Traders expect hikes in July and see the possibility of more hikes later in the year.

By the first quarter, market participants expect to see rate cuts with Fed funds dipping below 4%.

What does this mean for stocks?

That is probably the wrong question, with the index at 25 times earnings and the NASDAQ 100 PE now well over 30. Markets are overvalued, and the economy is expected to slow.

This is not a recipe for broad market success.

Putting cash into undervalued sectors like banking and real estate investment trusts is fantastic, however—especially on pullbacks. (Of course, you must avoid most office REITs until we see pricing that better reflects the reality of big city downtown office properties.)

The biggest opportunity is right in front of you, and most people are going to ignore it.

Unfortunately, most investors will pay attention to the headlines, click chasers, and focus on AI stocks at nosebleed valuations.

Historically chasing these big stories could work out better.

Many of you will embrace your inner Jesse Livermore and decide that you are a trader and use options to lock in these huge gains using the secrets of the ultra-elite to get rich.

But the ultra-elites’ real secret is that they do not use options trading to build their wealth. They own assets and businesses that produce cash flows.

Right now, one of the biggest opportunities for high total returns is not in stocks. In fact, current valuations, persistent inflation, and expectations for slowing economic activity as the year progresses, make the most popular stocks a poor bet.

The path for the fed funds rate laid out by both traders at the Chicago Mercantile Exchange and officials at the Federal Reserve are very bullish for fixed income.

Buying higher-grade corporate bonds and preferred stocks will pay off with outstanding total returns over the next year as rates peak and begin to normalize.

Even if they peak and plateau, investors who use market volatility to put money into fixed income should see returns that make equity investors blush with envy over the next year or two.

In my not-always-so-humble opinion, the best way to take advantage of this opportunity is with the heavily discounted fixed-income funds we have been buying in Underground Income. Both our taxable and tax-free portfolios have the potential for monster gains, in addition to high levels of current income.

While I prefer closed-end funds to exchange-traded funds, some ETFs can help you participate in the opportunities I see in fixed-income markets.

One is the Virtus InfraCap U.S. Preferred Stock ETF (PFFA). Jay Hatfield, the manager of this fund, is the best manager of preferred stocks in the entire ETF in the money management business. The fund currently yields more than 10% right now, and there is solid upside potential in response to eventual interest rate cuts.

I also like the JPMorgan Core Plus Bond ETF (JCBP) at its current levels. This ETF invests in high-quality bonds, including U.S. Treasuries, and will be a major beneficiary of the pause, hike, cut scenario.

Be smart with this ETF and make volatility your friend. Buy a few shares on days when bonds are down big in response to headlines. Accumulate on down days, collect the income, and plan on selling much higher next year.

This post originally appeared at Investors Alley.

Category: Stocks