After the FOMC: Three Things Investors Need to Know

In the midst of the noise, much of it political and therefore unhelpful for investors, here are the three most important things to know. None of these is widely understood, so those who get the message first will have an advantage.

  1. Everyone is starting to talk about stock prices as a multiple of 2014 earnings. It is silly, but it makes stocks seem cheaper. It would be better to look at the four-quarter forward earnings, but most people switch from one year to another around Labor Day. A possible cause of the enduring seasonal effect? Now that I have told you, you will see this trend in your daily reading and viewing.
  2. P/E multiples will continue to increase, despite rising interest rates, until the ten-year note gets to about 4%. Why? The relationship between stocks and bonds is not linear. When interest rates get very low, it reflects deflationary concerns. Basically, people do not believe the “E” so they accord a lower multiple to stocks. When the economy improves, rates rise and earnings become more credible. You can watch the pundits on TV comment on this with amazement and insist that it cannot continue. They are using a simple heuristic – too simple. The trend will continue and the ending forward multiple might get to 18 or so. This would not be unusual.
  3. It is not all about the Fed, despite today’s FOMC decision. Everyone who has been wrong about the market uses the Fed as an excuse. In fact, many worries have lessened and the oft-predicted recession did not happen. The world economy is better. Earnings are better. Get beyond the prevalent Fed obsession.

Investment Implication

Today’s FOMC surprise provided a reprieve for those who have pushed too hard in reaching for yield and embracing gold out of fear. If this sounds familiar, it is a good time to reassess your long-term posture. If you are overweight precious metals or interest-sensitive stocks, take another look. There is still time to rotate into investments that are better geared to long-run conditions. We implement a comprehensive plan, but happily share ideas. Here are some that we currently like:

  • Buy stocks with attractive values, dividends around 3% (no yield reach), and sell near-term calls against the position. This is safer than just buying stocks and much better for income than bonds. Example: INTC or MSFT versus short calls.
  • Substitute economically sensitive stocks for the high-yielding names. CAT and various tech names qualify.
  • Substitute more diverse material stocks for precious metals. I like FCX, which trades in correlation with gold but also has a larger copper component to gain from economic improvement.
  • Consider emerging markets. These went both up and down on over-reaction to the Fed. Bernanke made it clear that this is not a driver of Fed policy. Still, there are opportunities. We like ILF for a trade, and are looking at other long-term ideas.

Sometimes the news offers you a chance to reconsider what you are doing. This is such a time.

A Note to the Wise

You will find it easier to achieve your goals if you listen to sources that do not profit from pushing you toward a specific product. Contrast this with bond guys, hedge fund managers, or conspiracy mongers profiting from your page views, not their track record!

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  • Pacioli September 19, 2013  

    CAT seems to be frequent recommendation on the site.
    I assume you have seen the short thesis from Chanos and other re: CAT. What is your take?

  • oldprof September 19, 2013  

    Pacioli – There are a number of stocks that fit the economic thesis, and some have done better than CAT. It is just an example. You could choose CMI or FDX, for example.
    And yes, it is fair to assume that I follow all of the news on stocks that I own. Chanos gets a lot of buzz and I watched him yet again in his CNBC interview last night.
    I respect your question, but I don’t want to do a detailed defense of CAT in the comments. Let’s just say that I do not put much emphasis on things like grand supercycles, and I think there are better authorities on China. The company has also done a good job of managing costs.

  • Rich September 19, 2013  

    I appreciate your recommendation with regard to selling near-term calls when buying value stocks that offer decent dividends. Could you be more specific about the time-frame you have in mind?
    Thank you.

  • oldprof September 19, 2013  

    Rich — In my program I stick to the front month or two — seven weeks at most. This captures the most rapid part of the time decay curve. I start with stocks I am willing to own anyway (crucial) and sell calls that are a little out of the money and with a premium that would lead to an annualized return of 10% or so. If the stock rallies and is called away, I have made 4% or so in less than two months.
    I hope this helps 🙂