3 Reasons Why the Fed Made Right Move – and How You Can Profit... Dear Reader, I’m willing to bet that most of you folks have never landed an F-18 Hornet on an aircraft carrier. But I’m sure we can all agree that it is much more difficult and complex than it looks.
As the aircraft approaches those final moments before touchdown, the pilot will have to rely on a host of tools and instruments... not to mention some gut instinct to make any necessary last-minute adjustments. And that’s not even getting into the long list of things that could go wrong at any point during the entire process…
But the goal is simple. As you land, you want the tailhook to successfully engage one of the arrestor wires to quickly decelerate the aircraft. And just like that, you’ve got a smooth, successful landing.
I bring this up because you’ve probably heard a lot of talk over the past year or so about whether the Federal Reserve can achieve a “soft landing.” This refers to a slowdown in economic growth, usually caused by rising interest rates, without entering an outright recession.
And just like sticking the landing on a Nimitz-class carrier at a speed of 150 knots (175 mph), it’s easier said than done.
But this is exactly what the Federal Reserve was aiming for on Wednesday when it cut key interest rates by 0.5%.
I talked about what was behind the cut, as well as my assessment of Chair Jerome Powell’s press conference and the Fed’s new quarterly “dot plot” survey in Thursday’s Market 360.
Now, the Fed has a mixed record when it comes to achieving a soft landing in the past. But in today’s Market 360, I want to discuss three reasons why I think a 0.5% rate cut was the right move. I’ll also share an obvious way you can profit.
First, let’s consider a few reasons why I think a 0.5% rate cut is the right course of action… Reason 1: The Economy is Showing Signs of Weakness It’s becoming increasingly clear that there are some cracks emerging in the U.S. economy.
First of all, the American consumer is stressed. A recent report from the New York Fed showed that credit card balances reached a new record of $1.14 trillion. Credit card balances are up 48% since early 2021. About 9.1% of credit card balances are delinquent, and so are 8.0% of auto loan balances.
This is not good, folks.
In addition, the Fed released its latest Beige Book survey in preparation for the September FOMC meeting. The survey revealed that nine of the 12 Fed districts reported flat or declining economic activity in August.
Particularly alarming was the fact that manufacturing activity dropped in most districts, and the August payroll data reported that 24,000 manufacturing jobs were lost. Most districts also reported softer home prices.
In my opinion, the Beige Book survey gave the Fed all the evidence that it needed to cut key interest rates by 0.5% instead of 0.25%. And it will need to continue cutting at upcoming FOMC meetings until economic activity improves. Reason 2: Inflation Continues to Cool, but Unemployment is Rising As I’ve discussed many times, the fight against inflation is largely over, folks.
In fact, in last Thursday’s Market 360 I discussed both the recent Consumer Price Index (CPI) and Producer Price Index (PPI) reports. They showed that inflation continues to moderate.
What is important to remember is that the Fed’s favorite inflation indicator – the core Personal Consumption Expenditure (PCE) index – showed inflation is finally within the Fed’s 2% target. And I expect the August PCE report on Friday, September 27 to show inflation continues to moderate, and signal that the Fed is doing the right thing by cutting rates.
So, as signs that inflation is falling closer to the Fed's target, the central bank is now obsessed with unemployment… and for good reason.
The unemployment rate has jumped up to 4.2%, up significantly from 3.4% just 16 months ago. The Labor Department also made a big revision to the first quarter jobs data – showing that about 818,000 fewer jobs were created than initially reported.
What’s more, there are now barely more job openings than unemployed people. So, Jerome Powell was right in his press conference after the Fed’s meeting, when he said: “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with disinflation.” Reason 3: The Fed is Out of Line with Market Rates
I realize that the bond market may not be something a lot of investors are interested in. But it’s vital to understanding what’s going on in the rest of the market.
Treasury yields serve as a benchmark for other interest rates – like mortgages, auto loans and credit cards. If the Fed and the Treasury market are misaligned, it can lead to higher borrowing costs for consumers and businesses, and that's not good for economic growth.
What’s more, if the Treasury market responds negatively to Fed actions, it can undermine the effectiveness of monetary policy.
With this in mind, Treasury yields have continued to tick lower following the recent inflation data. The 10-year Treasury has fallen from 3.9% on August 30 to about 3.7% today. The two-year Treasury yield, meanwhile, has dropped from more than 4% in mid-August to 3.6% today.
Given the decline in Treasury yields, the Fed responded with its 0.5% cut, bringing the rate down to a range of 4.75% to 5%. And I think two more big rate cuts at its next policy meetings this year would be another great step for the Fed to right the ship and get back in line with market rates. Who Benefits from Falling Interest Rates? Now, with Treasury yields meandering lower and the Federal Reserve cutting rates, you might be wondering… What stocks benefit from falling interest rates?
It’s simple: smaller-cap stocks.
These are companies whose total market value, or market capitalization, ranges from about $300 million to $2 billion. Large-cap stocks, in comparison, have a market value of $10 billion or higher.
The appeal of small-cap stocks is that, because they are small, there is greater potential for big gains in a short period of time.
Small-cap companies can be some of the most innovative and profitable on the market. But the fact is that smaller companies have bigger debt loads than their large-cap peers and rely on external financing to fund their operations. With a rate cut, they can reduce their borrowing costs and put more capital towards their operations.
So, while smaller-cap stocks have traded erratically and underperformed large-cap stocks this year, a big rebound may be in the offing.
Just look at the Russell 2000 if you don’t believe me. Since September 6, the index has soared 6.5% higher – and that move has been nearly straight up! Meanwhile, my Breakthrough Stocks dramatically outpaced the small-cap index, though, rising nearly 10% in the past two weeks. Also notable, 13 of our Buy List stocks posted double-digit gains between 10% and 37%!
Bottom line, I think there is tremendous opportunity in select small-cap stocks right now – and it’s all about investing in the right ones. So, if you want to get in on the small-cap “melt up” that’s going on right now, I encourage you to give Breakthrough Stocks a try.
Click here to learn how you can become a member of Breakthrough Stocks today.
(Already a Breakthrough Stocks subscriber? Go here to log in to the members-only website.) Sincerely, |
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