Tread softly, Janet! Ever since last Friday’s sprightly jobs report, Wall Street has been rife with speculation that the Federal Reserve will boost short-term interest rates (for the first time since 2006) at its mid-December policy meeting.
In anticipation, the 10-year Treasury yield jumped on Monday to a four-month high of 2.38%, and remained at 2.32% in late New York trade today.
But will the Fed actually take the fateful step on December 16? And if the central bankers do finally push rates up, will the economy tolerate it?
I’m inclined to answer yes to the first question.
However, I’m a lot less sure about the second.
The case for a rate hike is fairly simple. Nearly everyone is calling for it, even some of the more dovish Fed members. If Yellen can’t act now, after a year of hemming and hawing, she risks looking ridiculous.
On the other hand, I worry about the economic repercussions. Not that a quarter-point rate increase would make much difference under normal circumstances. Nowadays, though, the unpleasant odor of deflation hangs heavy in the air.
Large swaths of the global business community are laboring under the burden of falling prices and shrinking profit margins. The deflationary spiral began in 2011 with the breakdown in prices for metals, lumber, fertilizer and other basic materials.
Oil and gas took the next hit, in 2014—a body blow that the industry and its investors (including us) are still absorbing. Today, the Energy Information Agency announced that U.S. commercial inventories of crude oil rose for a seventh straight week, to 487 million barrels, erasing nearly all the drawdown from the record reading last April 24.
As if these concerns weren’t enough, we’re hearing reports from retailers—such as Macy’s (M) this week—that their inventories are also running too high. If the inventory problem spreads, engulfing more businesses that rely on consumers’ discretionary spending, the Fed may have to beat an embarrassing retreat and cut rates in 2016.
In such a climate, how do we invest? More cautiously than usual.
I can envision taking more money off the table in late December or early January if the S&P 500 fails to break decisively through its May peak (2131). We’re in the strongest season of the year for equities. It’s time for the bull to stand and deliver.
If you’re underweighted in stocks, I suggest focusing your new purchases on companies that serve real consumer needs, not whims. Drug maker Merck (MRK) fits the bill.
I’m also warming to Pinnacle Foods (PF), producer of Birds Eye frozen vegetables and Duncan Hines cake mixes, among other popular brands. PF recently affirmed its guidance for 9%-10% growth this year in operating profits—an encouraging omen in a disinflationary/deflationary world.
While PF isn’t a rock-bottom-cheap stock (21X estimated 2015 earnings), steady, safe growers usually fetch a premium, and today’s market is no exception. Pinnacle attracted a takeover bid once before, in May 2014. Thus, I wouldn’t be surprised if another offer came along, somewhere down the road, at perhaps 20%-30% above today’s share price.
Finally, a brief note on the energy sector. The plunge of the past two weeks has knocked many good-quality master limited partnerships down to fire-sale levels. If you’ve been thinking of adding to your stake in this area, I advise you to go with the safer, lower-yielding names until we get more evidence that the downside price momentum has burned itself out.
There will be plenty of time to buy the highest yielders on the way back up. Best buy at the moment: Enterprise Products Partners (EPD).
